Getting vested in equity - what does that even mean?
December 7, 2014 3:05 PM Subscribe
My friend finally convinced me to help him with his company.
I have verbally guaranteed him a minimum of 5 billable hours/week in exchange for a percentage of equity in his company. What should the written terms be?
More:
When will I be "vested" and what does that mean anyway? What rights do I have as an equity owner? It seems like equity isn't worth anything until a company is sold, is that true?
In terms if billable hours, how should I take vacation? How should I approach when more hours are occasionally needed?
What other things should we make sure we have in writing?
More:
When will I be "vested" and what does that mean anyway? What rights do I have as an equity owner? It seems like equity isn't worth anything until a company is sold, is that true?
In terms if billable hours, how should I take vacation? How should I approach when more hours are occasionally needed?
What other things should we make sure we have in writing?
Best answer: It would probably be a good idea to have a lawyer for this one as it could get complex. Especially if this is a sizeable chunk of the company, which it probably should be if you're working for free.
The big things to figure out is what happens when you want to quit or when they want to fire you. It's not fair to them if you can just take off with a share of the company before you've put in the time. On the other hand it's not fair to you if they have a means of kicking you out after you've put in time but before your ownership has kicked in. Both of these things happen, even among friends.
Stock options are a common structure for this type of problem. You might have a contract in which you are guaranteed the right to purchase shares in the company at a certain price (or they might be given to you in consideration for your work), but only if you have spent a certain amount of time working at the company. That's what 'vesting' means. A 'vested' option has come of age, i.e. you have put in your time, and now you have the right to purchase shares in the company at the agreed rate. And if you exercise that right and spend the purchase price, you then own shares in the company. An option that hasn't vested yet is not worth anything; it is merely a promise to be worth something down the road if certain conditions are met. Google 'vesting schedules' to understand more of this.
Think of vested options as a paycheck for you. I would push for your options to vest regularly since you are working in exchange for them. You wouldn't work for free and then expect all of your money at the end of two years -- it should come to you gradually, as you go. Or you could suggest being paid in advance (with equity) with an agreement that the equity reverts if you quit. Again, lawyers know all the tricks and options and such.
The value of options comes when it is possible to sell your shares to someone else. In many cases, when a company is sold, this will include a purchase of shares, so some of the purchase money will go directly to you; options should hopefully automatically vest upon a sale, but again that's up to the lawyers to get right. In other cases, a company can go public, and those with ownership in the company can sell shares to the public, hopefully at a good price. And in the majority of cases, neither of these happen, the company limps along and eventually folds, and the shares are worthless. I would say your biggest question is to have an exit plan for yourself so that you don't continue to sink time into a doomed enterprise. Yes, figure out vacation, build that into the contract, but worry about the fundamentals of not getting screwed over and not wasting your time.
posted by PercussivePaul at 3:43 PM on December 7, 2014
The big things to figure out is what happens when you want to quit or when they want to fire you. It's not fair to them if you can just take off with a share of the company before you've put in the time. On the other hand it's not fair to you if they have a means of kicking you out after you've put in time but before your ownership has kicked in. Both of these things happen, even among friends.
Stock options are a common structure for this type of problem. You might have a contract in which you are guaranteed the right to purchase shares in the company at a certain price (or they might be given to you in consideration for your work), but only if you have spent a certain amount of time working at the company. That's what 'vesting' means. A 'vested' option has come of age, i.e. you have put in your time, and now you have the right to purchase shares in the company at the agreed rate. And if you exercise that right and spend the purchase price, you then own shares in the company. An option that hasn't vested yet is not worth anything; it is merely a promise to be worth something down the road if certain conditions are met. Google 'vesting schedules' to understand more of this.
Think of vested options as a paycheck for you. I would push for your options to vest regularly since you are working in exchange for them. You wouldn't work for free and then expect all of your money at the end of two years -- it should come to you gradually, as you go. Or you could suggest being paid in advance (with equity) with an agreement that the equity reverts if you quit. Again, lawyers know all the tricks and options and such.
The value of options comes when it is possible to sell your shares to someone else. In many cases, when a company is sold, this will include a purchase of shares, so some of the purchase money will go directly to you; options should hopefully automatically vest upon a sale, but again that's up to the lawyers to get right. In other cases, a company can go public, and those with ownership in the company can sell shares to the public, hopefully at a good price. And in the majority of cases, neither of these happen, the company limps along and eventually folds, and the shares are worthless. I would say your biggest question is to have an exit plan for yourself so that you don't continue to sink time into a doomed enterprise. Yes, figure out vacation, build that into the contract, but worry about the fundamentals of not getting screwed over and not wasting your time.
posted by PercussivePaul at 3:43 PM on December 7, 2014
PercussivePaul has listed some of the considerations for equity (options / shares). There are other important ones, too (particularly tax-related implications). There's no easy, one-size-fits-all way to do this, but many lawyers will have seen a variety of "off-the-rack" setups and will be able to figure out from your other circumstances which one(s) might fit with the smallest amount of custom tailoring. It's definitely worth contacting a lawyer if you think the business might take off and/or you value the friendship.
Although frankly, if you're only going to contribute 5 hours/week, I'm not sure you should expect a lot in the way of equity (and/or you should be skeptical of the business idea if you're offered 10-20% of the company). The transaction costs of setting things up properly will probably consume a lot of the value of your "free" work to the company.
Look at it this way: if your 5 hours/week is worth 10% of the company, then the whole company is worth 50 hours/week of your time. That's scarcely more than a 9-5 McJob. A start-up that's running on 50 hours/week is a start-up that's never going to get anywhere.
You can multiply the numbers out yourself as a sanity check -- you'd have to be Really Fscking Effective for your 5 hours/week to be worth more than a point or two of the company, and at that low share, the hassle factor / transaction cost for doing the paperwork right is really high.
posted by spacewrench at 4:08 PM on December 7, 2014 [1 favorite]
Although frankly, if you're only going to contribute 5 hours/week, I'm not sure you should expect a lot in the way of equity (and/or you should be skeptical of the business idea if you're offered 10-20% of the company). The transaction costs of setting things up properly will probably consume a lot of the value of your "free" work to the company.
Look at it this way: if your 5 hours/week is worth 10% of the company, then the whole company is worth 50 hours/week of your time. That's scarcely more than a 9-5 McJob. A start-up that's running on 50 hours/week is a start-up that's never going to get anywhere.
You can multiply the numbers out yourself as a sanity check -- you'd have to be Really Fscking Effective for your 5 hours/week to be worth more than a point or two of the company, and at that low share, the hassle factor / transaction cost for doing the paperwork right is really high.
posted by spacewrench at 4:08 PM on December 7, 2014 [1 favorite]
Best answer: When will I be "vested" and what does that mean anyway?
You set this out in the terms of the agreement. Being "vested" means that you own the asset without any restrictions. There are a variety of reasons for creating any kind of vesting scheme. Usually to prevent you from selling the asset as soon as you acquire it. If, for example, it was written into the agreement that you could sell your ownership stake back to the company for $10,000 (just to pick a number) you might get vested in it over four years at 25% per year. That way, if you sell one year from now, you only get $2,500, $5,000 at two years, etc. You have to hang onto it for four full years to get all the money out of it. Whether or not to create a vesting period, how it all works, what your equity is worth and how you go about selling your interest can all be created by you and your friend (almost certainly with a lawyers help) and can take any form you like. Make the vesting period some multiple of Planck's constant and require that both parties like the cut surface of a halved potato and then bury the potato to consummate the transaction if you like (okay, that last part might be tough to enforce).
What rights do I have as an equity owner?
As many or as few as the terms of your agreement stipulate. If the company is organized as a corporation or LLC, there might already be corporate by-laws that govern this. Usually by creating shares in the company and then defining what rights and responsibilities come with those shares.
It seems like equity isn't worth anything until a company is sold, is that true?
This is true of any investment. Until someone actually pays you for it, it's just paper. It seems less true with assets that are publicly traded on an open market because there is such easy access to sellers and there is pretty much always someone looking to buy. There is enough trading in those assets that we can assign a value to them and consider them to have value but they don't have any actual real value until you sell them.
Typically, you're going to get shares in the company. Since those shares aren't traded on an open market (like the NYSE) there aren't thousands of transactions taking place with supply and demand setting a market price for those shares. That is the only reason people who stocks have any idea what their shares are worth, thousands of other people have been buying and selling them all day. So, it'll be up to you to find someone to buy those shares from you and you'll have to figure out what they're worth then. You could be selling them back to the company or to some third party who may or may not be buying all of the other shares at the same time. Your friend could sell his share of the company to someone else and you could still own your piece. But, someone else offering to buy the company might be the most likely opportunity to sell your stock.
There are probably some standard provisions that a lawyer would know and you'll want a lawyer to help with the language, legality, and filing of the thing but other than that, the terms and conditions are really up to the two interested parties here to hash out.
posted by VTX at 4:53 PM on December 7, 2014
You set this out in the terms of the agreement. Being "vested" means that you own the asset without any restrictions. There are a variety of reasons for creating any kind of vesting scheme. Usually to prevent you from selling the asset as soon as you acquire it. If, for example, it was written into the agreement that you could sell your ownership stake back to the company for $10,000 (just to pick a number) you might get vested in it over four years at 25% per year. That way, if you sell one year from now, you only get $2,500, $5,000 at two years, etc. You have to hang onto it for four full years to get all the money out of it. Whether or not to create a vesting period, how it all works, what your equity is worth and how you go about selling your interest can all be created by you and your friend (almost certainly with a lawyers help) and can take any form you like. Make the vesting period some multiple of Planck's constant and require that both parties like the cut surface of a halved potato and then bury the potato to consummate the transaction if you like (okay, that last part might be tough to enforce).
What rights do I have as an equity owner?
As many or as few as the terms of your agreement stipulate. If the company is organized as a corporation or LLC, there might already be corporate by-laws that govern this. Usually by creating shares in the company and then defining what rights and responsibilities come with those shares.
It seems like equity isn't worth anything until a company is sold, is that true?
This is true of any investment. Until someone actually pays you for it, it's just paper. It seems less true with assets that are publicly traded on an open market because there is such easy access to sellers and there is pretty much always someone looking to buy. There is enough trading in those assets that we can assign a value to them and consider them to have value but they don't have any actual real value until you sell them.
Typically, you're going to get shares in the company. Since those shares aren't traded on an open market (like the NYSE) there aren't thousands of transactions taking place with supply and demand setting a market price for those shares. That is the only reason people who stocks have any idea what their shares are worth, thousands of other people have been buying and selling them all day. So, it'll be up to you to find someone to buy those shares from you and you'll have to figure out what they're worth then. You could be selling them back to the company or to some third party who may or may not be buying all of the other shares at the same time. Your friend could sell his share of the company to someone else and you could still own your piece. But, someone else offering to buy the company might be the most likely opportunity to sell your stock.
There are probably some standard provisions that a lawyer would know and you'll want a lawyer to help with the language, legality, and filing of the thing but other than that, the terms and conditions are really up to the two interested parties here to hash out.
posted by VTX at 4:53 PM on December 7, 2014
What's your best estimate of what the company is worth _today_? What is your time with to you? From those two questions, I think it's fairly easy to figure out what percentage you should get, to a first approximation. It gets more complicated by factors like whether you consider this more a favor than real work, or whether you really believe in the potential of the company for rapid growth (extremely, extremely unlikely if they want to pay you in equity rather than bring on investors who can pay people an actual salary).
From my experience with startups your equity, no matter what percentage you get is extremely likely to be worth nothing in the long run, think about it more like buying scratch off tickets than drawing a paycheck. I also bet that if you value your labor at the true cost and value his company at a realistic value, he'll probably balk at the percentage of the company you ask for.
posted by empath at 5:22 PM on December 7, 2014
From my experience with startups your equity, no matter what percentage you get is extremely likely to be worth nothing in the long run, think about it more like buying scratch off tickets than drawing a paycheck. I also bet that if you value your labor at the true cost and value his company at a realistic value, he'll probably balk at the percentage of the company you ask for.
posted by empath at 5:22 PM on December 7, 2014
Also, people who own businesses only hand out equity to people who have money to invest, or people who make a central contribution to the work of the business. If they're paying part time employees with equity, it basically means they're too broke to afford to pay people, don't have enough revenue, can't find investors, and can't get a bank loan or credit.
posted by empath at 5:28 PM on December 7, 2014 [3 favorites]
posted by empath at 5:28 PM on December 7, 2014 [3 favorites]
Response by poster: These are helpful answers!
To clarify, I am not working for free, but billing at what I would consider a significantly discounted rate in exchange for equity.
I am working my full-time job. This is less for me an opportunity to get rich, and more an opportunity to work on something I am interested with a little incentive.
posted by jander03 at 9:33 PM on December 7, 2014
To clarify, I am not working for free, but billing at what I would consider a significantly discounted rate in exchange for equity.
I am working my full-time job. This is less for me an opportunity to get rich, and more an opportunity to work on something I am interested with a little incentive.
posted by jander03 at 9:33 PM on December 7, 2014
This thread is closed to new comments.
posted by saradarlin at 3:24 PM on December 7, 2014 [3 favorites]