Can I get a better vesting deal for my stock options?

Aug. 1, 2000
Is it reasonable for my investors to demand that the founder's stock I hold be changed so it vests over time, like all other employees' stock options? Also, should I insist on accelerated vesting of my stock options if the company gets acquired?
1304qa Chang New

Q: Is it reasonable for my investors to demand that the founder's stock I hold be changed so it vests over time, like all other employees' stock options? Also, should I insist on accelerated vesting of my stock options if the company gets acquired?

A: In answer to your first question, there is a trust issue here. From your standpoint, investors could fire you to cheat you out of your stock ownership; this would be unlikely, if only for the practical reason that they would have to issue options to your replacement. From the investors' standpoint, a founder may quit or become non-performing and still take a big chunk of the company. This has happened a lot lately, especially in the dot-com arena. It is not uncommon for a founder to quit and start over again when the business model does not pan out.

You should do your best to convince your investors that you are committed. At the same time, check references with other companies your investors have invested in to develop a better understanding of their characters. It is also not unreasonable or uncommon for the two sides to compromise, like vesting half up front with the rest vesting over time. That's fair because you should be recognized for giving birth to the company. You may also consider putting in a significant chunk of your own assets to co-invest to show your commitment. Another thing you can ask for is to vest all your shares up front along with a buyback agreement on a vesting schedule. This way you can have long-term capital gains instead of starting the IRS clock at the end.

Now for your second question. From your standpoint, the acquiring company can easily combine your function with their existing executives, eliminating your job to achieve efficiency and at the same time lowering the purchase price with fewer shares. That can happen although the consequences can be severe in terms of company morale. From your investors' viewpoint, the value of the company is significantly diminished with accelerated vesting because people can cash out and there will be no one left to run the business. The acquiring company would have to issue new stock options, which is equivalent to buying the company at a higher price.

So, this is handled with the so-called "double trigger" vesting. Typically half of the stock gets vested at the time of the acquisition, and the other half gets vested if the job definition gets significantly reduced as a result of the acquisition or the employee is fired without cause. Accelerated vesting is generally limited to top executives—they are much more vulnerable than a person on the "production line" because executive functions are usually duplicated in the acquiring company.

Q: The VP of Business Development at a big company calls me regularly about acquiring my company, but nothing happens. How should I deal with this?

A: You can always give this company a deadline to make an offer because this kind of call is very disruptive to a small company. Most small companies assume that inquiries of this nature are serious, but it may be nothing more than this person doing his or her job to prospect for new opportunities. Knowing the opportunity may go away may be just what it takes to spur the caller into action.

Q: I have developed a components technology with government funding that will become important in three to five years as telecom bandwidth increases. Should I seek venture funding now to get ready for the market when it happens?

A: The argument against ramping up too early is that a lot can happen between now and then. Competing technologies can come into being, and changes in system architecture may lead to incompatibilities with your components. Investors evaluate their opportunities based on risk/reward ratios and return on investment (ROI). That means an investor betting on a business far in the future is taking a bigger risk and therefore will demand a larger ROI. That simply translates to retaining less ownership for a given amount of investment brought in. So, ordinarily I would recommend that you get more government contracts to help you further refine the technology for a year or two before seeking funding.

The flip side is missed opportunity, and we also have to be sensitive to the current environment because of the magic words: telecom, bandwidth, and technology. In this arena, the technology-to-market cycle is compressed, the payoff can be extremely large, and there is so much venture capital competing for so few good deals that you might just get funded at an enormously attractive valuation. The investment community is further encouraged to do so given that even companies with highly speculative and unproven technologies are being acquired for exorbitant valuations. It will be interesting to see how it all works out with the "insatiable demand for photonics investments" our industry is now enjoying.

About the Author

Milton Chang

MILTON CHANG of Incubic Management was president of Newport and New Focus. He is currently director of mBio Diagnostics and Aurrion; a trustee of Caltech; a member of the SEC Advisory Committee on Small and Emerging Companies; and serves on advisory boards and mentors entrepreneurs. Chang is a Fellow of IEEE, OSA, and LIA. Direct your business, management, and career questions to him at [email protected], and check out his book Toward Entrepreneurship at www.miltonchang.com.

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