Once you know the size of your grant and the percentage of ownership it represents, you should answer the questions in the checklist below before you take any action with an equity award in a privately held company:
- Is your award a grant of stock options (whether NQSOs or ISOs), restricted stock/RSUs, stock appreciation rights (SARs), or synthetic equity, such as phantom stock? Or does it consist of an interest in a limited liability company or shares deposited into an ESOP?
- How did the company devise its valuation method for setting exercise prices?
- How will you pay the taxes or exercise costs, given that you cannot sell shares to fund them? For example, does the company offer loans, or should you evaluate third-party financing for exercise costs? With any tax withholding, what methods are allowed or required by the company?
- Will the company create liquidity for its stock other than launching an initial public offering or being acquired by another company?
- What are the vesting rules? For example, is there an initial one-year cliff-vesting period from the date of hire or grant followed by monthly vesting? In addition, do the grants have a double trigger so that they fully vest only after an IPO, acquisition, or some other type of liquidity event?
- What are the SEC rules and contractual restrictions on resales of the stock after a liquidity event?
- How soon after an IPO can you sell the shares? What does the lockup allow? How does it differ from going public through a direct listing or SPAC?
- Are there buyback provisions and repurchase rights that allow your employer to repurchase shares if you leave the company? Alternatively, how soon after you terminate employment must you exercise options to avoid forfeiture? Would the exercise trigger a noncompete provision?
- Do you have early-exercise options? These provide the ability to exercise options immediately upon grant and receive restricted shares with a reverse vesting schedule.
- What special investors' rights, such as those related to dilution, liquidation preferences, and acquisition proceeds, affect your potential gains?
Alert: Review the stock plan, grant agreement, and any related communications materials. Ask your company or prospective employer for clarification if you are uncertain about any of these terms. In a startup company, you want to be certain a formal stock plan exists or is about to be implemented to avoid the risk that grants cannot be made.
Got another minute? In just 60 seconds, the myStockOptions editor-in-chief runs through the top 5 things to know about equity comp in private companies:
You must also understand the tax treatment, which can present a tax dilemma, as it's the same as that of equity awards at public companies (unless the grants fit into new IRC Section 83i). However, shares acquired from equity awards at pre-IPO companies are initially restricted securities, though they can provide the opportunity to pay 0% tax at sale when the shares are qualified small business stock (QSBS).
The financial-planning issues of equity awards at pre-IPO companies can be unique. To maximize the potential value of your grants, you should become familiar with the key planning points and know how your new grants are likely to change after your company goes public. See also the article on this website about negotiating and structuring your private company stock compensation.
