Startup companies often award restricted stock to founders and other employees or independent contractors. Realistically, some of the founders and service providers will leave the company after only a short period of time. How should the company protect itself against founders and service providers leaving the company before they have “earned” the shares? One answer is repurchase rights.
Repurchase rights generally apply to restricted stock awards. The repurchase rights allow the company to recover any shares from a stock award that are held by former founders and service providers that have not “vested.”
When a company grants restricted stock to a founder or service provider, all or a portion of the shares issued to the person should be subject to a vesting schedule. The vesting schedule basically is the period of time during which the repurchase rights expire. The purpose of the vesting schedule is to provide the founder or service provider with an incentive to continue with the company and help it succeed. If the founder or service provider continues with the company and satisfies the vesting criteria, he or she will own the shares outright. However, if the service provider leaves the company before the vesting criteria is met, he or she will forfeit the unvested shares.
The vesting schedule will typically extend over three or four years from the date of grant. During this period of time, the company retains the repurchase right over the unvested shares so that the unvested shares will revert to the company if the founder or service provider does not satisfy the vesting criteria. In effect, the founder or service provider will return the unvested shares to the company. If the founder or service provider paid a purchase price for the shares at the time of grant, the company will usually refund that purchase price when the shares are returned to the company. The award can provide for “cliff” vesting (i.e., all the shares vest at the same time once the time period has been satisfied) or, more typically, proportionately over time, such as monthly, quarterly or annually. Awards can also be subject to performance vesting based upon the company hitting certain goals, such as revenue or development targets.