Gunderson Dettmer executive compensation partners Liz Webb and Heather Aune participated in a closed TechGC Women's Collective dinner discussing financial wealth and stability, as well as methodologies for securing personal financial success. They provided guidance and insights on how executives and general counsels at high-growth companies should think about and approach executive compensation programs.
In preparation for this closed session, we previewed some top questions in a Q&A between the partners that highlighted considerations for venture-backed company executives and legal teams to navigate tough questions surrounding compensation and ultimately lead to greater financial success.
There are three primary types of stock-based compensation that emerging growth and technology companies use to reward employees: stock options, restricted stock awards (RSAs) and restricted stock units (RSUs). The best vehicle will depend on various factors, including whether the company is public or private, and, if private, the company’s stage of development and current valuation.
As a general rule, for an early-stage private company, restricted stock is most attractive. For a minimal cash investment, an employee can purchase shares in the company. From a tax perspective (assuming you file an 83(b) election!!), this allows you to start your long-term capital gains holding period. It also avoids a situation down the road where you have a stock option with a low exercise price but the taxes incurred in connection with an exercise would be high. While attractive in the early days, restricted stock generally doesn’t scale. As a company’s valuation rises, restricted stock quickly becomes too expensive for most employees.
At that point most companies start granting stock options. Options are by far the most common equity vehicle used by venture-backed companies and are attractive because of their flexibility. Employees can choose whether and when to exercise based on their financial situation and appetite for risk. In addition, options are generally straightforward to deal with in most M&A events, they offer the opportunity for long-term capital gains (if exercised) and the ability to participate in secondary transactions.
However if a company’s valuation gets very high options it may become less attractive. Employees may start to worry about limited upside and cost to exercise and a company may run into issues with dilution. As a result, we see some late stage high-value companies shift to granting RSUs. An RSU is a right to receive a share with no exercise price. The issuance of that share is a taxable event, so many private company RSUs have two vesting conditions (described below) designed to delay the taxable event until a company achieves liquidity.
For public companies, the most common equity instruments we see being utilized are options and RSUs. RSUs are increasingly popular because of market volatility and its impact on option exercise prices.
By far the standard vesting schedule for private venture-backed companies is four-years with a one-year That means no vesting occurs until you complete a year of service; after that vesting often occurs monthly, sometimes quarterly. If a private company is granting RSUs, there are typically two vesting conditions, one service-based and one that requires the company to undergo a liquidity event within a set period of time (typically in the range of 5-7 years). We’ve seen a small group of companies implement longer or back-loaded vesting schedules and a few have implemented shorter vesting schedules (e.g., three years).
In terms of acceleration of vesting, a so-called “double-trigger” is the most common. This requires two triggers to occur, a change of control and an involuntary termination, in order for an award to vest. With a “single trigger,” some portion of the award (e.g., 25-50%) will vest in connection with a change of control alone. Single triggers are much less common than double triggers.
Outside of the change in control context, you might see some acceleration in connection with an involuntary termination. Here the amount of acceleration often mirrors the amount of severance. For example, if an executive is entitled to six months of cash severance, they might get six months of acceleration. More often, executives can negotiate acceleration when they are terminated before their cliff has been met. In that instance, we see pro-rated vesting based on the number of months served or even the full 25%.
If you are receiving a stock option, it is important to pay attention to the post-termination exercise period. By far, the status quo is if your employment terminates, you have three months to exercise any vested options. If the exercise price is high, or if the value of the company’s stock has risen significantly, this can be cost prohibitive. Some companies offer something longer, e.g., 1-2 years or even up to the full 10-year term of the option to exercise your vested options. When we’re representing an executive and the value of the option is significant, one of the things we consider is whether they should ask for a longer post-termination exercise period.
You also want to pay attention to whether the company has transfer restrictions, either in its equity plan documents, in the company's charter, or bylaws. While these often aren’t negotiable points, to the extent you're hoping to take advantage of some secondary liquidity opportunities, it is important to know what you’re signing up to.
Additionally, early stage employees can sometimes pre-negotiate what's called an anti-dilution award. This occurs when private companies go through multiple rounds of financing, and those rounds dilute the existing stockholders and option holders. So you might be able to negotiate protection on one or maybe even multiple rounds of financing and receive additional option grants to return you to your pre-dilution stake in the company.
The marketplace is rapidly evolving and ever-changing in this area. Some companies are arranging organized liquidity programs, and if a company is high profile enough employees can also find secondary opportunities on their own. Organized liquidity programs, in particular, provide some nice opportunities for liquidity before the company has a traditional liquidity event. Obviously, there are no guarantees, and it is important to understand what contractual restrictions the company has in place so you understand whether they allow or prevent you from doing one of these transactions.
This is one that everyone wants to know the answer to! There are some surveys with market data that VCs and some attorneys have access to. The best ones people are talking about are TechGC's Compensation Surveys (keep in mind you have to be a TechGC member to get access!). If you are considering joining a public company, be sure to look at their proxy statement as it will have information about what certain members of the executive team are paid.