Founder Restricted Stock 101
By Sean Greaney: firstname.lastname@example.org
Originally published on Stubbs Alderton & Markiles, LLP
Sean Greaney, attorney with Stubbs Alderton & Markiles, LLP gives an informative introduction to Restricted Stock for startup companies. Sean’s practice focuses on corporate transactions, mergers and acquisitions, private equity transactions, and general corporate matters for both public and private clients, focusing on middle-market, emerging growth and development stage companies.
What is founder restricted stock?
Founder restricted stock refers to shares of common stock that are owned by a founder but are subject to forfeiture upon the occurrence of certain contractually agreed upon events. The forfeiture usually comes in the form of the company’s right to repurchase the shares for a previously agreed upon repurchase price. The repurchase price is generally equal to the price the founder paid for the restricted stock, typically a nominal amount. The company’s repurchase right in most cases is triggered by a termination of the founder’s employment or other service with the company, but can also be triggered by whatever other events the company and the founder agree upon.
As a founder, why would I want restricted stock?
Founders use restricted stock to ensure that the other founders continue to provide services to the company. This particularly comes in handy when there are multiple founders. Without the company’s ability to repurchase the founder stock, a founder may leave the company within three months after the company is formed and still own a significant percentage of the company. Also, let’s fast forward three years down the road when the company is sold for hundreds of millions of dollars. Even though that founder did not contribute to the success of the company, they would still be able to cash out their shares just like the founders who actually sacrificed their blood, sweat and tears for the company.
Restricted shares that are reclaimed from former founders can then be used by the company to allocate to new team members brought in to replace the departed founder.
In addition, investors in the company typically require founders to receive shares of restricted stock. When investors invest in a company, they are really investing in the founders and will want to incentivize the founders to continue working to build the company’s success. Therefore, if the founders want to receive funds from investors during venture capital rounds, they will generally be required to subject their shares to a company repurchase right.
Will my restricted stock always be subject to a repurchase right?
Generally, the company’s repurchase right gradually lapses over time pursuant to an agreed upon vesting schedule. Unlike stock options, the use of the term “vesting” in connection with restricted stock does not refer to the founder’s ownership of the restricted stock. A founder owns 100% of the restricted stock when it is issued. The use of the term “vesting” refers to the lapse of the company’s repurchase right with respect to the restricted stock. Founders typically have a vesting schedule pursuant to which the company’s repurchase right lapses over a period of three or four years.
I have heard the terms “single trigger” and “double trigger” used in connection with restricted stock. What do they mean?
The company and a founder can agree to accelerate the vesting of restricted stock upon the occurrence of certain events. When only one event needs to occur to trigger the acceleration, it is referred to as a “single trigger” and when two events need to occur to trigger the acceleration, it is referred to as a “double trigger.” Common events related to the acceleration of the vesting of restricted stock include a change in control of the company (i.e., a merger or sale of the company) and the firing of the founder without cause. If acceleration is based on a “single trigger,” then the occurrence of any one of these events would cause the company’s repurchase right to automatically lapse with respect to all or a portion of the restricted stock regardless of the vesting schedule. If acceleration is based on a “double trigger”, then both events would have to occur to accelerate the vesting of the restricted stock.
Section 83(b) of the Internal Revenue Code
The issuance of restricted stock may have tax implications related to Section 83(b) of the Internal Revenue Code. For a more detailed discussion of this topic, please read “An Introduction to 83(b) Elections.”