Equity economics are determined by the whole document set
The award notice may be only part of the picture. Other company and transaction documents can determine the executive's rights, the value of the award, and any restrictions that apply.
This overview is particularly relevant to executives, founders, and management teams considering or holding material options, restricted equity, profits interests, management equity, or other ownership rights.
What we help you understand
- What you own, when it vests, and what you keep if you leave
- Whether the company can require a sale and how the price and payment date are set
- When you can sell or otherwise receive value from the award
- Whether the ownership arrangement has tax or future-employment restrictions
Key questions about equity when employment ends
An equity award should be reviewed with a focus on termination. What is forfeited if the executive resigns, is terminated without Cause, is terminated for Cause, dies, becomes disabled, or experiences a change in control? Does vesting continue, accelerate, or stop? Are unvested and vested interests treated differently? Those questions often matter more than the stated number of shares or units.
Change in control protection and tax analysis
A sale or other change in control may determine whether an award vests, accelerates, is cashed out, rolls into buyer equity, or remains subject to restrictions. Termination is not required: accelerated vesting or other transaction-triggered equity or phantom-equity benefits may be relevant even if employment continues. In a transaction involving a corporation, those benefits and other transaction-related compensation may require analysis under Sections 280G and 4999 of the Internal Revenue Code.
Repurchase rights, valuation, and payment
The documents may permit the company or its sponsors to repurchase equity after termination. The governing provisions should identify who may exercise the right, what price applies, how value is determined, whether discounts apply, when payment is made, whether payment is in cash or a note, and what happens if the parties disagree about value. In private-equity arrangements, the company may retain valuation discretion or use a value based on its original acquisition price until a sale or other realization event; that valuation may differ materially from the value an independent third party would place on the company.
Option exercise deadlines after termination
Stock options often must be exercised shortly after an executive's termination or other cessation of service, commonly within 30 to 90 days, although the actual deadline is governed by the plan and award documents. If the deadline is missed, vested options may expire. An executive facing a departure should promptly ask the company for the information needed to make an informed exercise decision.
That information should include the number of vested options, the applicable exercise deadline, the total cash required to exercise, including any required tax withholding, and any call, repurchase, transfer, or other restrictions that will apply to the shares after exercise.
Liquidity and monetization
Equity can be valuable on paper yet difficult to monetize. The relevant questions include whether transfers are permitted, whether the executive has tag-along or drag-along rights, what happens in a sale, whether there are lockups, and when the executive can receive cash for the interest.
Tax treatment and restrictions attached to equity
An equity award can create tax without providing cash to pay it. The form of the equity and the timing of its grant, vesting, exercise, repurchase, and sale can affect tax treatment. Equity documents may also contain noncompetition, nonsolicitation, confidentiality, forfeiture, clawback, and other restrictions that are not apparent from the offer letter. The documents should be reviewed with the intended tax result in mind, including the possible application of Section 83, Section 409A, and other relevant rules.
Integrated equity experience
Ed’s Simpson Thacher training included both executive compensation negotiations and the management-equity arrangements that implement them. As a result, he is highly experienced in negotiating management-equity terms as well as executive compensation. That background is particularly relevant in private-company, private-equity, and management-buyout arrangements, where the equity documents often determine a substantial part of the executive’s economics.
Documents to request
A meaningful equity review may require more than the award notice. Depending on the structure, relevant documents can include the equity plan, award agreement, option agreement, restricted-unit agreement, shareholders agreement, operating agreement, LLC agreement, LP agreement, rollover agreement, and any valuation or repurchase policy.
Frequently asked questions
Is the grant-date value enough to evaluate an equity award?
No. Grant-date value does not answer whether the executive will vest, retain the equity after termination, be forced to sell, receive fair value, have access to liquidity, or receive the intended tax treatment.
Why review LLC or LP agreements?
For LLC interests, partnership interests, profits interests, and many management-equity arrangements, material economic and restrictive provisions are often contained in the underlying LLC or LP agreement rather than the offer letter or award notice.
What happens to executive equity when employment ends?
That depends on the governing documents and the reason for termination. The answer can differ for a voluntary resignation, termination without Cause, termination for Cause, disability, death, or a transaction. The documents should be reviewed before the executive accepts the arrangement or makes a termination decision.
Can a company require an executive to sell equity at termination?
Possibly. The governing documents may give the company or other holders repurchase rights. The reason for termination, the valuation method, the price, the payment timing, and any restrictive covenants can materially affect the result.
Can I owe tax on equity before I can sell it?
Yes. Depending on the type of equity and its terms, an executive may recognize taxable income at grant, vesting, exercise, settlement, or another event before there is a practical opportunity to sell the interest. In a private company, the executive may have little or no liquidity to pay the resulting tax.
Equity plans and award documents also often require the executive to pay the company the amount it must withhold for tax purposes, including upon restricted-stock vesting or option exercise. That can require a cash payment at the same time the executive recognizes income, even though the equity cannot readily be sold. The award and governing documents should be reviewed with the intended tax treatment, payment timing, valuation, withholding, and available liquidity in mind.
Why does the exercise price of a stock option matter?
An option granted with an exercise price below the stock's fair market value on the grant date can be subject to Section 409A of the Internal Revenue Code and create significant adverse tax consequences. The grant-date valuation and documentation therefore matter.
Why does it matter whether an interest receives the intended profits-interest treatment?
A properly structured partnership profits interest may qualify for favorable tax treatment. But an interest that does not receive that treatment may have current value that results in compensation income at grant or vesting, depending on its terms and applicable tax treatment. In a private company, the executive may have no ability to sell any portion of the interest to fund the resulting tax liability. The award and governing partnership or LLC documents should therefore be reviewed together.