Posted on April 20, 2009 by Stuart Campbell

What is a Repurchase Option?

Founders often ask how they can keep a co-founder who leaves the company shortly after formation from taking his founders’ stock with him. The remaining founders typically feel that the departing founder should not be able to share in the company’s future upside value. Similarly, investors typically want to prevent a founder from leaving with his stock shortly after making an investment.

Like employee stock options, founder stock can be subject to vesting based on service to the company. This is accomplished by the founder granting the company an option to repurchase his stock for the nominal price paid by the founder if he leaves the company before the stock vests. The stock “vests” periodically when a partner is released from the repurchase option. This is often referred to as “reverse vesting.” Note, investors sometimes give vesting credit for time a founder spent building the company’s value by exempting a portion of the founder’s stock (e.g., 25%) from the repurchase option.

For example, three founders could each agree on a repurchase option with quarterly vesting over two years with respect to their founders’ stock for which they paid $0.001 per share. In this example, 12.5% of the stock held by each founder would be released from the repurchase option quarterly such that at the end of two years all of the stock held by each founder would be free of the repurchase option and a founder would be free to leave the company with such stock.

When using a repurchase option, a founder should seek tax advice as to whether to file an 83(b) election with the IRS. Such an election enables the founder to include in income at the time of original issuance the value of the stock that is subject to repurchase. 

Tags: , , , , , , , ,
Posted on April 9, 2009 by Joseph M. Wallin

What's Better For An Equity Incentive--Restricted Stock or A Stock Option?

Early stage companies frequently want to bring on key hires and incentivize them with equity, but do not know what type of equity award is the best from a tax perspective to both the employee and the company.  There are in general two types of equity awards most commonly used (assuming that the company is operating in the corporate form and not as a limited liability company):

  • stock options; and
  • stock awards or stock grants.

In general, for a private company with limited cash reserves, and whose key hires also desire to preserve their cash (and not pay it to the IRS), stock options are usually going to be a preferable alternative to stock grants (unless the current value of the stock is so low that the immediate tax impact is nominal).  

The reason?  Stock grants will be taxable either (1) upon grant, if fully vested, or if a Section 83(b) election is made (in which case the taxes must be paid immediately upon grant, and will have to be withheld from the employee--i.e., the employee will have to write a check to the company for the taxes), or (2) upon vesting, when the value may be considerably higher than the value on the date of grant (and the taxes must then be paid at that time, and the employee will have to write a check to the company at that time for the taxes).  

The primary benefit of a stock option as opposed to a stock grant is that if the stock option is priced at fair market value on the date of grant, the receipt of the option is not taxable to the optionee, and the option will not be taxable at all until exercise--the timing of which the optionee controls (as opposed to a vesting date for a restricted stock award).

Tags: , , , , , ,
Posted on January 25, 2009 by Joseph M. Wallin

What Is "Reverse Vesting"

"Reverse Vesting" is an expression used to describe a situation in which an employee or independent contractor or consultant receives stock subject to repurchase by the company at an at-cost purchase price, which repurchase right lapses over the vesting period.  Thus, it is the reverse of the typical situation, where the service provider receives a right to purchase stock (an option) which right is not exercisable until the service providers vests.

Tags: , , , ,