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Tips: Common Stock Purchase Agreements Package

Document Tip (Common Stock Purchase Agreement with Vesting)

If the option is available, you should always pay cash for your shares of Common Stock so that both you and your startup can prove that the shares are “fully paid and non-accessible” under applicable corporate law. It is more difficult to prove that stock awarded for the consideration of services is properly fully paid and non-accessible. If you are a startup founder, consider paying cash for your shares of Common Stock and then assigning the business idea or plan, any filed IP, and all registered domains to the startup under your Restricted Stock Purchase Agreement.

Document Tip (Common Stock Purchase Agreement with Vesting)

Common Stock Purchase Agreements with Vesting for core founders and senior executives of your startup may well include an accelerated schedule for the lapse of repurchase rights (in other words, “accelerated vesting”). Be cautious when inserting these sorts of provisions. Why? Because, fair or not, many investors will react negatively to accelerated vesting provisions. When accelerated vesting provisions are discovered, potential investors will frequently review (with painstaking care) the vesting terms awarded to all of your startup’s key principals. Provisions that appear too generous to insiders can kill a financing that would otherwise have been completed. Remember that investors will make judgments about your sophistication based on the rights and terms that you have given to insiders.

Why do potential investors object so strongly to accelerated vesting? It is primarily a matter of their own self-interests. Think of it this way: investors invest money in your (or any) startup with the idea that its eventual sale will yield their original investment and some kind of profit. When your startup is sold, the acquirer will naturally want your startup’s key individuals to remain in place following the acquisition, at least for a period of time. Terms that allow key individuals to immediately depart following a sale – without repercussions – can drastically affect the monetary value of your startup. If these key individuals have the latitude to depart with no consequences, the acquirer of your startup will be left with no choice but to issue more equity or pay more cash in an attempt (which may or may not be successful) to motivate their continuing involvement in the startup’s day-to-day operations. Such uncertainty can absolutely lower the sale price of your startup and reduce the amount paid to investors. A lower sale price entails that your startup’s investors will receive a lower return on their investment. The moral of the story? Consider accelerated vesting terms for yourself and your key personnel carefully. There is no better glue with which to bind key personnel to an acquired startup than unvested shares of Common Stock.

If an agreement provides for accelerated vesting of shares of Common Stock issued to your startup’s founders and/or key executives, the terms are likely to be from 0% to 50% (of the unvested shares) on a single trigger and from 50% to 100% (of the unvested shares) on a double trigger. Most startups offer accelerated vesting provisions to between one and four individuals.

SmackDocs’ recommendation is that you do not provide accelerated vesting provisions in the event of employment termination if this can be avoided (includes terminations that are both change-of-control and non change-of-control related). Accelerated vesting terms like these are a recipe for discord within your startup, and educated investors and experienced acquirers know it all too well. Founders and other key executives who must remain with your startup following its sale (in order to earn their shares of Common Stock) will understandably resent the individual who is fired, and (having been fired) is able to walk away with full control of the shares of Common Stock that he or she was issued by your startup. This kind of arrangement essentially rewards an individual for being terminated. There is something else. New equity (shares of Common Stock) will almost certainly be issued to the terminated individual’s successor. When this happens, the value of the shares of Common Stock held by all others in your startup is diluted!

Document Tip (Common Stock Purchase Agreement with Vesting)

There is an important tax issue related to restricted stock issuances. Under Section 83(a) of the IRS Code, the difference between fair market value and any amount paid for shares of Common Stock will be taxable as ordinary income on the date those shares vest. If your unvested shares of Common Stock increase in value, the tax consequences later can be devastating. This is because the gain becomes taxable even if your shares are not liquid (cannot be sold for cash). Fortunately, there is a solution to the dilemma created by IRS Code Section 83(a). It is called IRS Code Section 83(b). Section 83(b) allows you to file an election, seeking to be taxed in the current year on the difference between fair market value of your unvested shares of Common Stock and the amount paid for those shares. In all likelihood, the difference in these two amounts will be zero, therefore the cost in taxes to you absolutely nothing!

It is good practice to file Section 83(b) elections at the time that restricted stock is purchased. In fact, you MUST file your Section 83(b) election within 30 days of the date upon which the shares of Common Stock were transferred to you (the purchase date of those shares), or they (the shares) will be permanently subject to treatment under IRS Code Section 83(a). When it comes to the Section 83(b) election, do not expect a mulligan if you miss that crucial 30-day window.

Document Tip (Common Stock Purchase Agreement without Vesting)

You should use this agreement with caution, especially if you are a technology startup. For technology startups, the more common (and accepted) approach is to use the Common Stock Purchase Agreement with Vesting. Technology startups in particular expect to seek angel or venture capital funding, and those investors prefer (and demand) that founders and other important early contributors to the startup receive stock that is subject to vesting. Vesting gives investors more comfort that key individuals (individuals who have been particularly significant to a startup’s prosperity) are likely to be contributors following their investment, a real advantage when it comes to projecting the startup’s long-term success.

Document Tip (Common Stock Certificate)

Stock Certificates do not have (are not actually required) to be issued. If you decide to issue stock certificates to your stockholders, you should issue them to all (not just some) of your stockholders and record the certificate numbers in a stock ledger.