It can be difficult to read the legal language in the documents you get when starting a new job at a startup. Yet these documents play a crucial role in startup compensation.
Which documents are most important? And what do the key provisions mean? Here is a list of the key documents you should keep on your radar as a private company employee.
The company's equity incentive plan
A company's equity incentive plan is also called the employee stock option plan. It outlines the company-wide program of granting different types of equity compensation.
The typical types of stock and stock options include:
- restricted stock
- incentive stock options (ISOs)
- non-qualifying stock options (NSOs)
- restricted stock units (RSUs)
- stock appreciation rights (SARs)
Options are the most common form of equity compensation for employees. They can make up a meaningful part of the overall compensation package offered to a startup employee. They also make you a shareholder of the company.
The equity incentive plan describes the process for granting and exercising stock options. It often outlines transfer restrictions, which may limit who, when and how much equity employees can sell while the company is still private. It also may include details about the company's right of first refusal.
Grant documents
Grant documents issue your options or other awards. These documents typically include a Notice of Grant and a Stock Option Agreement.
The Notice of Grant will list, among other things, the number of shares for which you have an option to purchase, the exercise price, the vesting start date, the vesting schedule, and the expiration date of the options.
The Stock Option Agreement will describe the terms of your grant, including how to exercise options, how the vesting schedule works, and any restrictions in place.
Exercise documents
You will often use a Notice of Exercise when you exercise your options. It includes details like the number of shares you are exercising, the price per share, and the total price paid. Sometimes, the company will also include some disclosure regarding the tax consequences of exercising your options.
The company should also provide you with IRS Form 3921, which provides the fair market value (FMV) of the stock at the time of exercise. The FMV is an important metric to consider when assessing the value of your equity.
Shareholder agreement
Once you exercise your options, you will often receive and sign a Shareholder Agreement or Restricted Stock Agreement. Whereas the Stock Option Agreement governs the terms of your options, this agreement will govern the terms of your share ownership. Important provisions include your rights to information, voting rights, transfer restrictions, and the company's right of first refusal.
Share certificates
Once you exercise your options, the company or their legal counsel may issue you share certificates. Keeping any physical share certificates securely is important, but it's also smart to have a PDF version handy. Take note of the legends on the certificates, which contain important information about transfer restrictions.
More recently and frequently, companies are using equity administration platforms to manage share issuance and ownership instead of issuing physical share certificates. Some of the most popular equity administration platforms include Shareworks, Carta and Pulley.
Company by-laws
Recently, some companies have started including provisions in their by-laws that can impact your rights as a stockholder. Such provisions include restrictions on your ability to sell your shares and rules you’ll need to abide by to do so. For this reason, it's good to request the by-laws from the company. In the absence of this, you can ask for written confirmation that there are no provisions that materially impact your rights as a shareholder.
Separation letter
If you leave the company, you will be provided a separation letter, often called a “Letter of Termination”. It's important to read this carefully and keep it on file. If you have options, the separation letter will inform you how many options you have vested, the exercise price, and how long you have to exercise those options. This is crucial information to give you a comprehensive view of your equity and option ownership. Exercising your options before they expire is important to make sure you don’t lose out on equity you have earned during your employment.
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