3 Points to Understand Before Signing an Options Agreement

Wednesday, April 18, 2012 0 No tags Permalink 0

When you join a startup full time, you will likely be compensated in cash and equity. For the equity portion, you will sign an options agreement. When I had to sign one several years ago, there were a few key items I should’ve understood much better than I did before I signed. Here they are:

(disclaimer: not a lawyer! This is totally situational advice.)

1) Terms and Strike Price– Typically, options have a vesting schedule of four years with a one year cliff. A cliff is a portion of time where your options will not vest (usually 1 year) and then vest at the date the cliff ends. This is meant to weed out members who may not be a good fit as well as to make long term hires.  After you’ve reached the cliff, your options will likely vest each month or each quarter. Make sure you understand exactly how your options vest, and what the strike price is. The strike price is what you will pay to execute your options, as opposed to the actual value of a share of stock in the company. So, for example, let’s say when you join the startup, a share of stock is worth $1. You have it written in your options agreement that your strike price is $1.

The company grows, and four years later, you decide to execute your options. Now, the value of a share is $4. You will pay to execute your options at $1 per share and receive the difference, $3 per share. Your strike price may decrease if the company stock gets diluted in funding rounds.

2)Single Trigger vs. Double Trigger Acceleration- Within your options agreement, buried under legal terms, are the implications of what will happen if your startup goes through a liquidity event. Though this may seem really far off, the startup world is unpredictable at best so it’s important to understand what will happen to your unvested options should the company go through an acquisition. Vested options are yours; you can execute them as stated in the agreement. However, many different things may happen with your unvested options. There is an important distinction to understand here: single trigger acceleration vs. double trigger acceleration. According to Brad Feld,

 “Single trigger” acceleration refers to automatic accelerated vesting upon a merger. “Double trigger” refers to two events needing to take place before accelerated vesting (e.g., a merger plus the act of being fired by the acquiring company.) Double trigger is much more common than single trigger. Acceleration on change of control is often a contentious point of negotiation between founders and VCs, as the founders will want to “get all their stock in a transaction – hey, we earned it!” and VCs will want to minimize the impact of the outstanding equity on their share of the purchase price.

Essentially, single trigger acceleration is preferred by you because all of your unvested options would vest upon an acquisition. Woohoo! You’ve worked your butt off for two years and your startup gets acquired…if you’re on a four year vesting schedule, you get a full two years worth of options ahead of schedule. Obviously, this is not in the best interest of the acquirer because they have to pay you that much more regardless of whether you will continue working.  If they can minimize their costs and they want you to continue working after the acquisition, they will offer you a job with at least those unvested shares continuing vesting on schedule (this can be negotiated) with the possible addition of a new vesting schedule of shares of the new company.

Note that it’s likely you won’t see the words “double trigger” in your options agreement. It’s important to understand the concept and try to parse the meaning out of the legal language.

3) More details about the acquisition- In addition to understanding what happens to your unvested options, you should look into the language regarding the kind of offer the acquiring company can give you. There can be language put in that protects you. For example, let’s say the acquiring company specifies that you have to move cross country, if you have language put in that prevents your moving within 20 miles (hypothetically) this could be the double trigger that would accelerate the vesting of unvested shares. Or, let’s say the acquiring company gives you an offer, but it’s half of your current salary. Language in your options agreement regarding a “reasonable” position could protect you and be the trigger for accelerated vesting.

I’m not a lawyer, and I did not have a lawyer look over my options agreement before I joined a startup (red flag!). I asked a couple of mentors and did some research to make sure I understood the salient points. However, after going through the process of an acquisition, I wish I had understood and negotiated for these points before signing the options agreement. There’s not a ton of research available online, but here are some good resources:

A Newbie’s Guide to Startup Compensation

7 Common Questions About Startup Employee Stock Options

Quora

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