Equity Plans Part I – The Sooner the Better

“The time has come, the time is now . . . ” quote from the book “Marvin K. Mooney Will You Please Go Now!” by Dr. Seuss

Hopefully many of you remember this fabled line and for me, it is what comes to mind when I think of the right time to finalize most equity plans. (I am using equity plans to cover anything which resembles ownership – from stockholder agreements to shadow equity plans.) Sooner is almost always better as delays always seem to have unwanted complications. To confuse matters further, my next blog is Equity Plans Part II – Are We There Yet? So before you conclude I have probably gone off the deep end (a concept constantly reinforced by my family) let me begin with a true story.

In the early 90s, leveraged buyouts (or LBOs as they were known) were the rage and I participated in my fair share. I was called in to help one group of four very qualified managers who were buying a half dozen plants from their parent company. The four covered different disciplines and were great at what they did – – they were just lacking in the skill set needed to buy and set up a separate company / operation. So we focused on the deal for about three straight weeks; long days with hard tasks and two days before closing, the five of us went to lunch. I brought up the subject of equity plans and shareholder agreements among the four. The CEO let me know that considering what was pending, bringing this up at that time was the “dumbest thing he ever heard.” I backed off but shortly after the close, I persisted and we finalized the equity plans. Six months later the CEO called with the heartbreaking news that one of the four had passed unexpectedly. While distraught over the loss, he came to appreciate the fact that all settlements related to ownership had been concluded during a less emotional time and he came to appreciate that fact.

Here is another situation which highlights why it is best to conclude on any equity plans as early as possible. Going through a transaction is stressful, and I have had a handful of situations where trying to finalize an equity type bonus when a sale was pending almost cratered a deal. Owners see the chance at monetizing their lives’ work becoming a reality while key employees believe they were responsible for creating that value and should be rewarded. Incentive and reward plans go from a thank you with benefits to a hard fought negotiated settlement and at times, transactions suffer. All of this stress can be avoided by addressing this issue earlier in the process when a sale is hypothetical and parties are more prone to have a logical view of how an equity plan should work.

So the punchline is that when you have concluded on the sharing portion of any equity plan, be it shares in the company, options, stock appreciation rights, etc., then the time is right to finalize the plan and complete the documents to avoid the hardships and risks that delay can bring. If you are an owner thinking of this issue, the time is now to address it.

It Does Not Say That; Does It?

It Does Not Say That; Does It?

“The devil is in the details.” – quote with various attributions

As I reflect on what has been keeping me so busy these last few weeks, I realize that there are three problem situations that have their roots in owners not fully understanding (or reading) certain underlying documents. Now I know everyone is busy and all of us have been guilty of asking a more knowledgeable advisor, “What does the document say?” Fortunately, in most cases, we get a complete picture but in many cases, there are some final changes added that the owner may not see (there is something called “deal fatigue”) so they do not do a final read. So let me highlight my three recent situations.

In the first, I was asked to review an equity option plan and stockholder’s agreement for a prospect that was a growing company. As one of my hot buttons is any provision which requires the Company to provide liquidity to the option holder, I asked if there was such a provision and the CEO was adamant that he would never provide for it but there it was in the agreement. It clearly stated- – if an option holder exercises and leaves for any reason, the Company has to buy back the underlying shares at the then fair market value in cash within 90 days.

In the second, a buyout agreement between two shareholders of a very profitable and growing prospect required the surviving shareholder to buy out the deceased shareholder’s interest at full fair market value. What made this standard provision very unusual was that it stated any shortfall between fair value and any life insurance proceeds would be covered by a full recourse note with short payment terms. In a call with one owner and the current corporate attorney regarding this agreement, that current attorney was incredulous and used some choice “legal terms” to describe his reaction.

Finally, using a combination of informal legal advice and documents obtained off the internet, two shareholders in a startup filed incorrect 83B elections in addition to creating some major tax problems with the timing and incorrect data on various formation documents. The situation as described to us was fine; unfortunately, the underlying documents bore no resemblance to what was intended.

We were able to find solutions to each of these situations, but that is not always the case. So some simple advice to all entrepreneurs. Documents, especially those related to ownership, should never be signed without a reading and thorough understanding of what they say. There are no stupid questions in this area; and ignorance can really cost you. And if legal counsel tells you when to sign something; sign it then and not later. Many documents are time sensitive and while it might seem like a small issue, if it is ever challenged, you will find that what is documented is what is considered done and the devil will be in those details. Please do not let them come back to haunt you.