Some of the top questions we get from startup clients and founders involve restricted stock purchase agreements. Our guide breaks it down for you.
A restricted stock purchase agreement is common among startups and ventures, but many founders wonder why it is used, its advantages, and disadvantages. Here’s a quick guide that provides an overview.
What Is A Restricted Stock Purchase Agreement?
A restricted stock purchase agreement often comes up during the course of issuing stock to the new owners of the startup. Stocks and shares in a new entity can be simply issued to the new shareholders, or they can be issued subject to a written agreement. A restricted stock purchase agreement is a type of written agreement that places restrictions on the stockholder’s rights with respect to the shares being issued. The restrictions generally restrict selling, transferring, etc. of the shares and grant a series of rights in favor of the Company to buyback shares, exercise a right of first refusal, and others.
Restricted Stock Purchase Agreements (RSPAs) play a vital role in the equity structure of many startups, allowing founders and early employees to acquire company stock at a predetermined price. However, navigating the complexities of RSPAs can be daunting for founders. This article aims to provide a comprehensive overview of RSPAs, highlighting crucial considerations for founders to keep in mind. By understanding the key elements, potential pitfalls, and strategies for mitigating risks, founders can make informed decisions regarding equity distribution and foster a healthy startup ecosystem.
Practical Uses in Investor-Backed Ventures
Restricted Stock Purchase Agreements serve as the foundation for issuing restricted stock grants within a company. These grants involve the issuance of company shares to recipients subject to specific vesting restrictions. Key elements to understand about RSPAs include:
- Restricted Stock Grants: RSPAs involve granting restricted stock to founders, employees, or consultants as an equity incentive.
- Vesting Periods: RSPAs establish the duration over which the restricted stock shares become fully vested and transferable to the recipient.
- Purchase Price: RSPAs determine the price at which the restricted stock shares can be purchased by the recipients, often at a nominal value or a discounted rate.
RSPAs are often used with founders and founders’ shares in investor-backed ventures for a number of reasons. Importantly, with respect to investor-backed ventures for which the goal of the startup is to eventually head towards an IPO, investors generally want to see the founders’ shares to the founders being taken in a manner that preserves the company’s ability to take action if things are not working out with the founder. It is often hard for founders to separate themselves from the company, especially since the founders are the company, at least at the beginning. But angels, investors, and venture capital firms rarely feel the same way about a company that the founders do – it is an income vehicle, like any other, and not a lifelong passion, dream, or pursuit as it may be for the founders. From and investor perspective, not all founders make good CEOs, and there may be circumstances in which the company and the founders have to eventually part ways. That is where the restricted stock purchase agreement comes in – it’s the equivalent of a prenuptial agreement between the founders and the company.
Common Terms, Rights, and Restrictions
RSPAs tend to involve similar types of provisions, and below is an overview of what founders are typically asked to commit to. As with all things in the startups & ventures industry, there are no black/white rules, and instead, many gray areas that are the result of what an investor is and isn’t willing to agree to, so some of these issues may not even come up, especially if the founders are not following the conventions for investor-backed ventures. Some startups, for example, are businesses that the founders want to run for life – regardless of whether investors can be found or not.
- Vesting. Investor-backed ventures typically ask that the founders take stock subject to an RSPA that contains a vesting schedule. Vesting spreads out the ownership of the stock in the founder over time, so that the founder takes shares over a 3 or 4 year period of time. From the investors’ standpoint, this prevents a situation whereby the founder owns his/her shares, gets a huge investment, and then quits, keeping all of the shares as their own. When a vesting schedule is used, the shares being issued to the founders “vest” over a period of time.
- Right to Repurchase. An RSPA will typically allow the Company to buyback shares from the founder through a repurchase option. The repurchase option can be triggered by a number of events, including the founder being fired or force to quit.
- Single / Double Trigger Acceleration. These provisions refer to a right that the founder retains to “accelerate” the founders’ vesting and ownership in shares in the event the founder is fired without cause, or if there is a change in control of the company that results in the ousting of the executive.
Key Considerations for Founders
Founders play a critical role in structuring RSPAs to ensure fairness, alignment of interests, and compliance with legal requirements. Several key considerations for founders when designing restricted stock purchase agreements are as follows:
- Founders’ Equity Split: Determining the initial equity split among founders is a crucial decision that can impact the long-term dynamics of the startup. Factors such as founders’ roles, contributions, and anticipated future responsibilities should be considered to allocate equity fairly.
- Vesting Terms: Establishing appropriate vesting terms is essential to align the interests of founders and the long-term success of the company. A standard four-year vesting period with a one-year cliff is commonly employed, requiring a minimum commitment before any equity is earned.
- Accelerated Vesting Triggers: Founders should carefully consider circumstances that may trigger accelerated vesting, such as change of control, acquisition, or termination without cause. Including such provisions safeguards the founders’ interests in unforeseen events.
- Buyback and Repurchase Rights: RSPAs should outline the company’s rights to repurchase shares from founders under specific circumstances, such as departure from the company or violation of non-compete agreements. Founders must evaluate the implications of such provisions and negotiate favorable terms.
- Tax Implications: Founders should be aware of the potential tax consequences associated with restricted stock grants. Understanding the difference between early-exercise and standard vesting approaches can help optimize tax planning and minimize tax liabilities.
- Intellectual Property and Non-Disclosure Agreements: RSPAs should incorporate provisions addressing intellectual property ownership and confidentiality to safeguard the company’s assets and proprietary information.
- Securities Law Compliance: Founders must ensure compliance with applicable securities laws when issuing restricted stock. Working with legal counsel to navigate securities regulations and exemptions is crucial to avoid legal pitfalls.
- Shareholder Agreements and Exit Strategies: RSPAs should align with broader shareholder agreements, addressing key provisions related to liquidity events, voting rights, drag-along and tag-along rights, and dispute resolution mechanisms.
► Getting Legal Help
AXIS Legal Counsel’s Startups Practice provides legal advice to numerous startups and businesses, founders and investors with a wide range of business matters. We represent early-stage companies as well as established businesses on a wide variety of technology business law matters, ranging from contracts and transactions, intellectual property, labor/employment law, business financing, mergers and acquisitions, real estate, insurance, business succession planning, and general advice and counsel. For information on retaining AXIS Legal Counsel to represent your business in connection with any legal matter, contact [email protected] for a confidential consultation.
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