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I have a verbal agreement with a pre-seed startup to do some work for them on a part-time, consulting basis. We had agreed to some cash and a specific equity percentage and vesting schedule (x% over y years).

I got the contract today, and the only place stock is mentioned is in the following paragraph, which seems to be talking about a stock incentive plan for me to purchase stock, not for me to just be granted it as part of my compensation:

Subject to the approval of the Board of Directors of the Company, the Company may grant to you an incentive stock option (the "Option") under the Company's 2018 Stock Incentive Plan (the "Plan") for the purchase of an aggregate of 72,000 shares of common stock of the Company at a price per share equal to the fair market value at the time of Board approval. The Option shall be subject to all terms, vesting schedules and other provisions set forth in the Plan and in a separate option agreement.

How do I interpret the above statement? It doesn't seem to say anything about my agreed on equity stake in the company as part of my compensation. Should it? What language would it use?

  • Usually stock options have a "buy in" price. For example they would grant 100,000 shares with a $1 buy-in. If the stock price values at $5/share when you sell, you would get $4 share for it. – Ron Beyer Nov 7 at 23:18
  • @RonBeyer is correct. – Putvi Nov 8 at 19:31
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How do I interpret the above statement? It doesn't seem to say anything about my agreed on equity stake in the company as part of my compensation.

You are right. The written clause is inconsistent with the verbal agreement.

If you sign the written contract, it would supersede the verbal agreement because a contract typically replaces and supersedes any prior [overlapping] agreements between the parties. Also, it is easier to prove the formation of a written contract than the terms of a verbal and unrecorded agreement.

The written clause provides that your compensation (or part thereof) will be in the form of call options, which has nothing to do with the equity percentage per the verbal agreement. You will need a clause that clearly reflects the verbal agreement: x% to be delivered in y years.

If you decide to go for the stock options plan, you need to be aware of some vulnerabilities that the written clause entails.

The clause is unclear as to when the Board would approve the Plan. The problem with that uncertainty is that the strike price is made dependent on the date of approval ("fair market value at the time of Board approval"). The Board could deliberately render your compensation negligible by approving the plan with a timing that minimizes the difference between fair_market_value_at_expiry_date and strike_price (that is, the max(S-K,0) expression).

That vulnerability can be preempted by determining the strike price beforehand and independently of the fair market value on an undefined date of approval.

The clause or the "separate option agreement" should include language to the effect of addressing stock splits, since the clause is in terms of number of stocks rather than percentage of equity. Stock splits would dilute the value of each one of the 72,000 shares the plan would entitle you to purchase. Absent a contractual protection against that dilution of shares, the startup could split stocks so as to deliver the plan stocks without actually giving up much of its equity.

I haven't really searched for case law regarding compensation in the context of stock splits. But, although you might be entitled to relief in case the company indulges in manipulation/fraud of the stock price, it is in your best interest to avoid litigation risks by ensuring that the language of the contract reflects your understanding and your expectations.

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    Woah, call options are contracts on publicly traded stocks. Private companies do not have call options. – Putvi Nov 8 at 19:28
  • @Putvi Being private company or publicly traded stocks is irrelevant to the OP's matter. The clause meets the characteristics of a call option of which the underlying asset is the company's shares. – Iñaki Viggers Nov 8 at 21:09
  • Yeah, I agree it's not relevant to the question. I'm just saying its not a call option. – Putvi Nov 13 at 17:16
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This is a complicated area of business and law. As the letter says only the board can authorize the stock deal and any executive who promises otherwise is making a big mistake. If they were to grant you options at lower than the market value there can be imputed income now that you can be taxed on. Sometimes that is a good thing and there is form I once filed with the IRS that says “tax me now even though this option may prove worthless in the future” to avoid larger taxes later.

Of course the number of shares is meaningless without knowing the total number of shares. Stock splits will not normally be an issue but dilution can be a big issue. The letter cites an existing stock option plan. You need to have a copy of that. Hopefully it addresses the stock split issue and otherwise clarifies what you are potentially being offered.

If you were a venture capitalist putting in money for stock you would have an agreement that protected you the in the stock split case, dilution, and many other actions like the company officers assigning the IP to a new company and leaving you with shares in a company with no assets. As a contractor you will not be able to get the protections a VC would get and, unfortunately, some trust will be needed to be extended on your part for this to work out in practice.

  • You have no idea what you are talking about. The point of options is to get them at lower than market value. Please read the links in my answer that directly contradict what you have said. – Putvi Nov 13 at 17:39
  • "This means that even if the value of the company skyrockets, you’ll still be able to buy your shares at the price they were at when you were given the options." smartasset.com/taxes/stock-options-tax – Putvi Nov 13 at 17:40
  • You get the option with a strike price at the market value at the time the option is granted. Later, after the stock skyrockets, you exercise the option at the strike price which then, of course, is much lower than the then current market value. – George White Nov 14 at 2:13
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The other answers show some legal knowledge, but no business knowledge.

Stock options are something you purchase. They are not just given to you by the company. https://smartasset.com/investing/how-do-stock-options-work

It can cost the company more money, in taxes, to give you shares than it would to allow you to buy them at a certain price. https://smartasset.com/taxes/stock-options-tax

Most companies won't just give you stock, they give you the option to buy it at a decent price.

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    A stock option can be given to someone. Later, at the exercise of the option, stock is purchased at the favorable option price. Also, if a company\y gives someone shares, it is the somebody that would owe taxes on that income, not the company. This answer shows nether significant law knowledge nor business knowledge, in my opinion. – George White Nov 8 at 20:08
  • I never said it was not purchased at the favorable price and yes the business does pay taxes. Read the links. @GeorgeWhite – Putvi Nov 13 at 17:36

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