If a startup does not understand company repurchase windows, and the company forgets to repurchase during the rapidly passing window of time that it is allowed to repurchase shares, then employees can walk away with more shares than they’ve earned and there’s absolutely nothing the company can do about it.
The whole point of vesting on a restricted stock award (RSA) or early exercise option is that if someone with shares walks away before they’ve earned their shares, you can take them back. But this repurchase window is part of the “taking them back” piece. If you forget this piece, the vesting could be for naught.
When Do You Need to Worry About This?
This blog post applies in cases of early exercise or founder RSAs when shares are purchased prior to vesting, for instance (1) an RSA that is subject to vesting and all shares have not vested yet, or (2) an ISO or NQO granted under a plan that the employee has exercised and the exercised shares having vesting but have not fully vested yet. If you have any doubts, contact your lawyer to see if you fall in a category where you need to worry about this.
The Window of Time for Repurchase
If shares are granted under the plan, and it's an RSA or an EARLY EXERCISE ISO/NQO, then when the employee leaves, the company needs to buy the unvested shares back. This is also called repurchasing. Usually, the company has 180 days (6 months) to repurchase shares from employees. How do you know if the company has six months to repurchase shares? It might be a slightly different time frame depending on the terms of your documents. The Stock Incentive Plan documents will clearly state what the window of time is for repurchasing unvested shares.
This clock runs from the date of termination. So, you'll have to (1) determine what the termination date is of the ex-employee and (2) do the math of how many days there are between today and when they were terminated. Assuming the company has 6 months, if it’s less than 180 days, you’ve still got time left to repurchase and get the company’s shares back.
A Real Life Example
I find that reading theory is not quite the same as reading real language in your own documents and trying to figure out what’s going on. Here's typical language from a sample Stock Incentive Plan:
"Such repurchase rights may be exercised by the Company within six months following the date of such Termination Event."
This is how you’d know you have six months (not seven or eight)—you have to go straight to the Plan.
Slipping Through the Cracks
Repurchasing shares is tricky because the responsibility to terminate is usually an HR function, and yet repurchasing is mostly done by whoever runs equity, which is often a different person (for example the CFO or maybe the General Counsel). These two people must coordinate to make sure repurchasing shares doesn’t fall through the cracks, which would allow the ex-employee to stroll away with perhaps 4 or 5 times the shares they earned.
Hopefully keeping these concepts in mind will prevent ex-employees or founders from walking away with more shares than they’ve earned. That way you won’t be accepting unnecessary dilution or giving away more control than you have to. The shares will go back to the company, and you’ll be able to re-grant them to reward people who are still hard at work making your company successful.
Learn more about how Fidelity can help you manage all of your company equity needs.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.