.svg)
Imagine you've just launched your startup, and it's already making progress. Investors are showing interest, and you're ready to bring on team members with equity as part of their compensation package.
While you're excited about the growth, you're overwhelmed by the complexity of creating and sending equity agreements- a common challenge for startup founders managing multiple responsibilities with limited resources.
Equity agreements help startups outline the terms of ownership and investment. They ensure all parties understand their rights and obligations. Templated equity agreements can simplify this process by providing a consistent framework for managing equity distribution.
In this article, we'll explore the best practices for using templated equity agreements in startups. By following these guidelines, you can create equity agreements that align with your startup's unique needs.
Overview of Templated Equity Agreements
Equity agreements are important documents for startups; they outline the terms under which ownership stakes are distributed to employees, investors, or other stakeholders.
These agreements set the foundation for the company’s ownership structure. They also play a key role in attracting and retaining talent and securing investment.
A templated equity agreement outlines the distribution of equity in a startup. It ensures all necessary components are included and reduces the risk of omissions or inconsistencies.
Components of a Templated Equity Agreement
Here are the main components of an equity agreement template:
Vesting Schedule
It specifies how and when the recipient earns the equity. This could be time-based, milestone-based, or a combination of both. Vesting schedules help ensure stakeholders have a long-term commitment to the company's success.
For example, a common vesting schedule might be four years with a one-year cliff, meaning that no equity is vested during the first year, but after that, the equity vests gradually over the remaining three years.
Ownership Percentages
They specify the percentage of the company that each stakeholder owns. This transparency helps maintain trust and prevents disputes. Each stakeholder's contribution and role in the company are reflected in these percentages, making it clear how the ownership is divided.
Cliff Periods
These specify an initial period during which no equity is vested. If the stakeholder leaves the company during the cliff period, they do not receive any equity. This protects the company from losing significant ownership stakes to short-term participants.
For instance, if an employee leaves the company within the first year (the typical cliff period), they walk away with no equity, ensuring that only those committed to the company benefit from ownership.
Rights and Obligations
They outline the rights of equity holders, such as voting rights and dividend entitlements, as well as any obligations they have, such as non-compete clauses or confidentiality agreements.
These ensure that equity holders align with the company’s goals and values, thereby protecting the company’s interests while granting fair rights to the stakeholders.
Exit Strategies
This component shows the terms under which equity can be sold, transferred, or otherwise exited. It addresses scenarios like buyouts, mergers, or the sale of the company.
Exit strategies also ensure that all parties know what to expect and how to proceed when significant changes occur in the company’s ownership structure.
Factors to Consider Before Sending Out Templated Equity Agreements
When preparing to send out templated equity agreements, there are several factors that you must consider to ensure the agreements are both legally sound and tailored to your startup’s specific needs.
These factors include:
Legal Compliance and Regulatory Requirements
Before sending out any equity agreement, you must ensure the document complies with relevant laws and regulations. This includes federal, state, and local laws that govern equity compensation.
Non-compliance can result in severe penalties and jeopardize the company's legal standing. It is advisable to work with a legal professional to ensure all regulatory requirements are met.
Customization Needs Specific to the Startup’s Situation
While templated agreements provide a solid foundation, they must fit your startup’s circumstances.
You can achieve this by adjusting the vesting schedule, specifying the type of equity being offered (e.g., stock options, restricted stock units), and outlining any company-specific terms or conditions.
Clarity and Simplicity
The equity agreement should be written in clear and understandable language. Avoid legal jargon and complex terms that may confuse stakeholders.
Clear communication ensures that all parties fully understand the terms and conditions of the equity agreement. This prevents disputes down the line.
Flexibility for Future Changes
Your equity agreement should be flexible enough to accommodate future changes, like additional funding rounds, changes in the management team, or modifications to the company’s equity structure. This ensures that the agreement remains relevant and effective over time.
4 Best Practices for Sending Out Templated Equity Agreements
The tips below will help you send out your startup’s template equity agreements effectively:
#1 Ensure Consistency Across Agreements
Consistency in equity agreements maintains fairness, transparency, and legal compliance within your startup.
Here are some best practices to ensure uniformity across all your templated equity agreements:
- Use clear, concise, and unambiguous language in all agreements. This helps to avoid misunderstandings and ensures that everyone is on the same page.
- Standardize clauses like vesting schedules, ownership percentages, rights of first refusal, and termination conditions. This ensures that all stakeholders are subject to the same rules and conditions, fostering a sense of fairness.
- Regularly review and update your templates to ensure they comply with current legal standards.
- As your startup grows and evolves, your needs and priorities might change. Regularly updating your equity agreement templates ensures they align with your business objectives.
- Implement a system for tracking changes to your templates. This can be as simple as maintaining a change log that records what was altered, when, and why.
- Clearly label each version of your agreement templates with a version number and date. This helps to avoid confusion and ensures that everyone is using the most current version.
- Store all template versions in a single, accessible location. This ensures that everyone in the organization can access the same, most up-to-date templates.
- Regularly train employees involved in drafting or managing equity agreements on the importance of consistency and the procedures in place.
#2 Communicate the Equity Agreement to Stakeholders
Effectively communicating the equity agreement to stakeholders ensures transparency, understanding, and trust.
The tips below can help you achieve this:
- Translate legal and financial terms into plain language that stakeholders can easily understand. Use analogies and examples to explain complex concepts.
- Focus on the most important aspects of the agreement, such as vesting schedules, ownership percentages, and any potential dilution of shares.
- Include charts, graphs, and tables to visually represent data and key terms. Visual aids can help stakeholders understand the agreement's structure and implications more quickly.
- Organize in-person or virtual Q&A sessions where stakeholders can ask questions and receive immediate answers. This interaction builds a deeper understanding and addresses concerns on the spot.
- Attach a cover letter to the equity agreement that summarizes the main points and the significance of the document. This letter should include a warm introduction, the purpose of the agreement, and an invitation to reach out with any questions.
- Ensure that the information shared during meetings, via email, and in written documents is consistent. Misalignment can confuse and erode trust.
- Conduct webinars or interactive workshops where stakeholders can learn about the agreement in an engaging, dynamic format. Record these sessions for those who cannot attend live.
#3 Include Detailed Vesting Schedules
Vesting schedules encourage team members to stay with the company longer. Employees have a tangible reason to remain committed and contribute to your startup’s growth by gradually earning equity over a set period.
The main elements of a vesting schedule include the cliff period, graduated vesting, acceleration clauses, and double-trigger vesting.
Here are some best practices for creating vesting schedules for your template equity agreements:
- Outline the vesting terms in the equity agreement and ensure all parties understand the schedule and conditions. This includes specifying the cliff period, the rate of vesting, and any acceleration clauses.
- Customize the vesting schedule to fit your startup’s specific needs. Consider the company's growth stage, industry standards, and goals when determining the vesting terms.
- Regularly review and update the vesting schedules to reflect changes in company policy and legal requirements.
#4 Track and Manage Signed Agreements
Efficiently tracking and managing signed equity agreements maintains organizational integrity and ensures all parties are on the same page.
Here are some best practices to help startups handle this task:
- Use a reliable digital signing service like DocuSign or Adobe Sign to ensure the agreements are legally binding and easily accessible.
- Create a centralized repository for all signed agreements. This could be a secure cloud storage solution like Google Drive, Dropbox, or a dedicated contract management system. Ensure the system is organized with clear naming conventions and folder structures for easy retrieval.
- Limit access to signed agreements to authorized personnel only. Use role-based access controls to ensure that only those who need to view or manage the agreements can do so.
- Ensure that your storage and management practices comply with relevant data protection laws and regulations, such as GDPR or CCPA, to safeguard the privacy rights of individuals involved.
- Conduct regular audits of your agreement repository to ensure all documents are accounted for and correctly filed. Check for any discrepancies or missing agreements and rectify them promptly.
- Periodically review signed agreements for accuracy and completeness. Ensure that all required signatures and information are present and that there are no errors or omissions that could lead to future disputes.
Common Mistakes to Avoid
When dealing with templated equity agreements in startups, you must be aware of common pitfalls that can undermine the effectiveness of these agreements. Some of these mistakes include:
Overlooking the Need for Legal Review
While templates can save time and money, they are not a substitute for professional legal advice.
Every startup's situation is unique, and it's important to have a legal expert review the agreement to ensure it complies with local laws and adequately protects the interests of the company and its stakeholders.
Using Very Complex or Ambiguous Language
Equity agreements should be clear and straightforward. Avoid legal jargon and overly complex language that can confuse the parties involved. Ambiguities in the agreement can lead to misunderstandings and disputes down the line.
More so, ensure that the terms are defined clearly, and the language is simple enough for all stakeholders to understand without needing extensive legal interpretation.
Failing to Update the Template as Needed
A templated equity agreement that was appropriate last year might not be adequate today. Regularly review and update your templates to reflect changes in laws, industry standards, and your company's circumstances.
Ignoring this can lead to non-compliance issues or agreements that no longer align with your business needs.
Ignoring Customization Needs
While templates provide a great starting point, you may need to modify them to suit your startup’s needs. Failing to customize a templated agreement can result in terms that are too generic or irrelevant to your situation.
Ensure that the agreement addresses the unique aspects of your business and the specific arrangement with each stakeholder.
Not Providing Adequate Explanations to Stakeholders
An equity agreement is only effective if all parties understand its terms. Don't assume that everyone will interpret the agreement correctly.
Take the time to explain the terms and implications to your stakeholders, and provide opportunities for them to ask questions. This can help prevent disputes and ensure everyone is on the same page.
Wrapping Up
As revealed in this blog post, a well-drafted templated equity agreement is not limited to allocating shares; it also sets the stage for future growth and stability.
By implementing the best practices discussed in this blog post, your startup can streamline issuing equity, minimize legal risks, and maintain positive relationships with stakeholders.
Remember, while templated equity agreements can save time and resources, they should not replace professional advice. Always consult with an expert to ensure that your agreements are fully compliant with current regulations and tailored to your specific needs.
FAQs
What is an equity template?
An equity template is a legal document that outlines the rights and responsibilities of a company's shareholders. It's also sometimes called a stock option agreement or shared equity agreement.
The template helps startups and companies with multiple shareholders avoid confusion and conflict by clearly defining expectations.
How do you write an equity plan?
Writing a strong equity plan involves outlining how you'll distribute ownership (equity) in a company to incentivize and reward employees or founders. Here are the steps involved:
Define Goals and Objectives
What are you hoping to achieve with the equity plan? Is it attracting and retaining talent, aligning employee interests with company goals, or rewarding founders? Having clear goals helps determine the type and amount of equity to allocate.
Choose the Right Equity Vehicle
There are several options like stock options (incentivizing purchase of company stock), restricted stock units (RSUs - grant shares that vest over time), or employee stock purchase plans (ESPPs - allow employees to buy company stock at a discount).
Determine the Equity Pool
This is a designated portion of the company's total shares set aside for equity grants. Consider factors like company stage, funding rounds, and future dilution (reduction in ownership percentage with new grants).
Vesting Schedule
This defines the timeframe over which employees earn full ownership of their granted equity. Vesting schedules can be time-based (cliff + vesting period) or performance-based (tied to achieving milestones).
Grant Terms
Specify the eligibility criteria for receiving equity grants (e.g., job title, seniority). Also, outline the exercise price for options (price to buy the stock) or purchase price for ESPPs.
Plan Administration
Decide who will oversee the plan (board, committee) and how grants will be managed. Consider using equity management software to streamline the process.
What are the 5 components of equity?
The 5 common components of equity include:
Share Capital (Common Stock and Preferred Stock)
This is the money shareholders invest directly in the company by buying shares. It represents the ownership stake that shareholders have in the company.
Additional Paid-in Capital (Share Premium)
This is the amount of money received from shareholders that exceeds the par value (a nominal value assigned to a share) of the common or preferred stock. It reflects the extra money shareholders pay on top of the face value.
Retained Earnings
These are the company's profits that are not paid out to shareholders as dividends. They are reinvested back into the business for future growth and operations.
Treasury Stock
This refers to shares of a company's stock that it has bought back from investors but hasn't canceled yet. These shares reduce the number of outstanding shares (shares held by public investors) and can impact earnings per share.
Reserves and Surplus
This is a category that can include different items depending on accounting practices. It may include funds set aside for specific purposes, unrealized gains or losses on investments, or additional profits beyond retained earnings.
