Offered a Position and Shares in a Start-Up? – 10 Traps in the Legal Papers, and Your Ways Out

“The spirit of our verbal agreement was true partnership, but
over time it morphed into this one-sided employment arrangement.”

– Actual Client Comment

ACTUAL CASE HISTORY: Kent was the Senior Editor of a major sports-related magazine. He was recruited away by a competing start-up publication, induced to leave his employer of many years by a promise of great wealth to be achieved through his becoming a minority shareholder of the new or young company. Kent gave the new magazine credibility, and for joining he was offered a large number of “Class B” interests in the company.

“When we are sold, or go public, you will become quite, quite wealthy” he was many times told by the start-up’s founder and investors. That was repeated so many times that Kent had already begun to consider where he would purchase his retirement dream, a horse farm.

Through an heroic contribution of energy, imagination, devotion, daring and perseverance, Kent helped the new magazine take significant market share away from larger, more-established competitors. He treated the new magazine as “his baby.” On a salary lower than he was used to, and minimal benefits, he built quite a powerhouse in just a few years. Sure enough, the magazine had attracted great interest, and a communications consortium came forward seeking to purchase the company that owned the magazine. For Kent, however, that was the beginning of his problems.

It all started with a casual management meeting that devolved into a discussion of Kent’s poor judgment, and then an announcement that Kent was being let go. It got worse when he learned that, because he was being let go, he would lose all of his unvested stock. Still worse, he found out that the company had a right to repurchase his vested stock for just $3,000. A third type of stock Kent had been given as a bonus had been so “diluted” by the company issuing 10 million new shares to investors that his remaining interests were worth about $45.00. Finally, he was reminded that the original documents he signed provided that Kent could now not work in the magazine industry for the next 24 months.

No job. No stock. No future. The dream had, somehow, turned into a nightmare. When Kent protested that this was not consistent with the spirit of the deal, he was simply advised, “Speak to your lawyer . . . the one who let you sign those papers.” That is when Kent called us – and not his previous lawyer – to try to salvage the situation.

More times than I can count,: someone contacts my firm and says, “I am being offered a new job. As part of the compensation package, they are offering me shares or units in the new or young company. Can you help me?” My answer is always, “Sure, I have done that many times.” A more candid answer would be “Sure, I have done that many times. However, it’s not an easy thing to do.”

“Why?” you might ask. It is not easy because lawyers for business founders or owners – particularly “Private Equity” owners, almost always make it difficult, and intentionally so. They do so in three basic ways:

First, by purposeful confusion. That is, by preparing three or four different agreements that, together, constitute one offer: (1) one that pertains to employment; (2) one that pertains to non-competition agreements, (3) one that pertains to company self-governance, itself, and (4) one that pertains to earning, vesting and possibly losing ownership interests. It’s a lot of words, a lot of pages and a lot of jargon. No single employee can understand it all. It is quite rare to find an attorney who has experience in each field. In this way, the key points – and real risks – get buried.

Second, through dreams of sugarplums. As the saying goes, “The large print giveth, and the small print taketh away.” Said a bit differently, the potential rewards are highlighted, while the likely risks are made quite difficult to spot, and even more difficult to remedy. Thus, clients begin to count their eventual wealth, which naturally blinds them.

Third, with complexity of cure. When you have three of four separate agreements, often in different typefaces, often without page numbers, always with different paragraph numbering systems and – most complex of all – with hard-to-understand, almost irrational definitions of words and phrases.

There are just too many ways, in too many different places, that the risks are effectively hidden, and the rewards are potentially forfeited. It is something akin to the game of “Whack-A-Mole,” where every time a mole appears from the ground, and you whack at him, another mole pops his head up from another mole hole.

In no other part of my practice of decades have I seen more “bait and switch” than I have in this context. The employee must make life changes and agree to restrictions NOW in return for a mere PROMISE of something to be delivered later, which “something” may in all likelihood never come to be, or if it does come to be, is perhaps 1/1000th as valuable as originally suggested.

LESSON TO LEARN: The task before us is tough: making real – at least likely – the dream opportunity, which by the legal papers has been diminished, made unlikely, and often turned into a nightmare reality by confusing, confounding and complex legal drafting. One thing the legal drafting is not is accidental. Rather it is quite intentional. That is the one thing I can guarantee you.

No matter how difficult the task at hand may be, you are so much more likely to be successful in it if you know what you are doing. Thus, by knowing the essential deal points in this context, and knowing how to address them, can only be helpful.

So long as your requests for change in the legal papers is respectfully presented, reasonable in magnitude and accompanied by a rationale – that is “I want to join you. I just need some things made clearer before I can comfortably come aboard.”

Simply signing what is before you, and hoping that you will be treated “fairly,” is not something that I have seen work out well for employees. And, too, you owe it to yourself and your family to try to avert calamity in your quest for that pot of gold. Here’s how:

WHAT YOU CAN DO: Some people can read and analyze legal documents without falling asleep, but there are not too many who can. Even lawyers have a hard time discerning the meaning and effect of legal documents that are written – intentionally – in an obtuse fashion. And, trust me, in this context that is almost always how they are written.

My suggestion is that you try to review your employee-with-ownership documents yourself, first, and see if you can spot the problems I point out below. You may then be able to raise your concerns by yourself.

You may be wise, as well, to try to locate an attorney to help you. He or she should, though, have experience in this precise transaction. Of course, you may share with the attorney the insights below. An attorney is especially important if and when there is any negotiating to do on the language of changes in the documents.

Whatever you do, do your best to avert a disaster. Better not to enter into too dangerous a situation than to tempt fate and in the process find yourself, your family and your career, in a very difficult spot.

Read on for the 10 issues you need to address, and how to best address them.

1. The Best Way to Try to Modify What is in the Documents: A “Superseding Addendum”: As noted above, becoming an employee-owner usually entails signing three or four separate documents, each of which is tied to the other in a rather confusing manner. So, how can you most efficiently and effectively make modifications to three or four different documents? By suggesting changes in each of the four? No. The complexity and interrelatedness make that quite near impossible. Rather, it is by one “Addendum” that modifies all of them at once.

The word “addendum” means a list of changes to a book, report, letter or contract that modifies it. Instead of rewriting an entire book, report, letter or contract, you can modify it by making a list of changes that is added to it, and put them into a second agreement that is then considered “added” to it. Hence the name “Addendum.” A “superseding” addendum says, in effect, “No matter what Agreement A, Agreement B, and Agreement C say, from now on they are changed to say “X, Y and Z.”

One single superseding addendum is surely the most efficient and effective way to request changes be made to three or four documents in one place, and by one effort: namely the superseding addendum. There are no magic words in a superseding addendum. It just has to express that, no matter what is in Document A, Document B and Document C, what is in this Addendum supersedes and overcomes all provisions that are in each of them.

2. Terms of Your Employment: One of the documents you will be asked to sign will related primarily to your employment relation. This document, whatever it is called, usually has two points that need to be raised by you, namely that if either (a) any material changes are later made in your employment relation (such as a reduced salary or a change in the location of your office), or (b) if your employment is terminated other than for your having engaged in truly gross wrongful conduct, in either instance, all of your unvested stock or units of ownership immediately vest. As is the case in any agreements, there are no “magic words” you need to us; just make sure the intended meaning of your words is clear.

3. Your Ownership Interests: You will probably be told that your ownership interests will represent a certain percentage of ownership in the company, perhaps 25%, or perhaps 2%. No matter what your ownership interests may represent, that percentage may be reduced to 1/1000 of one percent if 5 million new shares are issued by the company, an event called “dilution” of interests. Just as glass of wine would be diluted by mixing in a quart of water, so, too, might this happen to your ownership percentage.

Don’t look for words that say, “Your interests could be reduced by a factor of 1/1000; it’s never that clear. But trust me, the rather obtuse language of the documents will likely provide that it may happen to you.

To prevent that from happening to you – that is, your interests going from 25% to .0000025% – request that language be inserted that would prohibit the company from diluting your interests, or at least diluting your interests any more than it dilutes the interests of the founders of the company.

Negotiating the terms of a New Job? We offer a 152-Point Master Checklist of Employment Negotiation Items to help you “remember everything and not forget anything.” To obtain a copy, just [click here.] Delivered by Email – Instantly!

4. Intellectual Property You Create: I have seen clients hired into companies with promises of equity that vest over time, provided they take a very low salary for a while. They are then given the goal of creating very valuable intellectual property – a graphic design, a computer code, algorithms, a music score, etc. – and then, when the intellectual property is completed, they have been abruptly terminated, before they vest in a single share or unit of ownership.

To prevent this from happening to you, request that the intellectual property you create on your job is presumed to always be owned (a) by you 50% and (b) by the company 50%, until all of your equity has been vested in your ownership.

5. Non-Competition Agreements and Other Post-Employment Restrictions: One of the riskiest elements of the many points that employers commonly require employees to agree to in order to become an “employee-owner” is that the employee agrees that he or she will not work in the industry, or any competitor, for two years if his or her employment relation with the company ends “for any reason.” Those last three words – “for any reason” – are the killer. That would permit the employee’s employment to be terminated by the Company, for example, without reason after only two weeks, and result in an inability to work in the industry for two whole years.

Employees should ask that such non-compete provisions be effective if and only if (a) they have voluntarily resigned, (b) they are receive full salary and benefits throughout the non-competition period, (c) the restrictions apply only to direct competitors, and, (d) if their resignation is after material elements of their employment terms have been reduced, then if all their ownership interests are immediately vested.

Asked to sign a non-compete agreement? Protect your career. How can you respond? How should you respond? Our “Model Letter: Response to Request You Sign a Non-Compete” shows you “What to Say, and How to Say It.™ To obtain your copy, just [click here.] Delivered by Email – Instantly!

6. “No Less Favorable” Treatment of the Employee’s (a) Employment Terms, and (b) Ownership Interests: It is quite common that employees given employment agreements later find their salaries cut, benefits reduced or terminated, and workplace relocated beyond commuting distance.

(a) The Superseding Addendum presented by the employee or employee’s Legal Counsel should include a provision that such things will not take place unless, all others employed by the employer are treated the same way, simultaneously. We call this “No Less Favorable” treatment.

(b) As to the employee’s ownership interests, the same should be required vis-à-vis the ownership interests of the founders and all other owners, namely, that the employee’s ownership interests cannot be diluted, denied preferential treatment afforded other owners, or treated differently as to dividends, distributions of profits, or otherwise.

7. Require Repurchase Rights be Exercised at an Honest Price: There is commonly a provision in these legal papers that permits the Company to repurchase from you your ownership interests in certain events. What should the price be . . . one determined by the seller and buyer, or one determined solely by the Company, itself? Of course it should be the former, in a fair negotiation.

But, sure enough, the legal papers presented to employee-owners almost always say that any repurchase by the company or other investors will be at a price “determined solely by the company, in its good faith.”

I have written a blogpost entitled “Robbery by Repurchase Rights” that I recommend you read.

It is for this reason that you should insist that the price to be paid to “repurchase” your ownership interests, under any scenario, should be one that is openly and thus fairly determined, that is, by negotiation between the “seller,” meaning you, and the “buyer, meaning the Company or anyone else.

8. Resist any and all Presumed Forfeitures: The legal papers given to employees to sign to become employee-owners almost always provide that in many different instances the employee forfeits all of his ownership interests. As examples, (a) if he or she leaves the company for any reason; (b) if he or she has acted in a manner that damages the company’s interests, including reputational interests, or (c) if he or she does not perform his or her services in a satisfactory manner.

But (a) what if the employee resigns because she is being severely harassed? (b) What if it is not true that the employee acted in a way that have damaged the company? (c) And what if the employee’s performance review is way off base? How and when does this get a fair hearing?

In the case history noted above, Kent was falsely alleged to have engaged in poor judgment. As a result, without a hearing or review of any kind, he was deemed to have forfeited the ownership interests that he had earned by years of great effort.

For this reason, an employee or his or her Legal Counsel should request that no forfeiture of ownership interests should be deemed to have taken place unless and until a Court has ruled that the alleged forfeiture has a sound basis in fact.

9. Request a Legal Fee Reimbursement Provision: As you might imagine, disputes sometimes arise between employee-owners and their managers, just like they do in many contexts. In this context, considering the importance that these issues be resolved carefully, especially if the employee has given years of extraordinary service, but the issue arises before he or she has received the anticipated “pot of gold.” Without the reimbursement of legal expense, most employees cannot afford to resolve such issues.

And legal disputes can be so very expensive. What employee has money to spend on lawyers, especially when unemployed? And, too, the company surely has more money in its pockets available to spend on lawsuits than the employee does.

For this reason, you would be wise to consider asking that, in the event of a dispute becoming a litigation, the company reimburse you for raising the issue or defending yourself in good faith for the legal fees incurred on a monthly basis, as that is most likely how often your lawyer will be expecting to be paid.

10. Finally, Insist on a “No Unsigned Changes” Clause in Your Addendum: Believe it or not, the legal papers you are given to sign will likely provide that the owners of the company, present and future, can change (a) the “rules” about how owners are treated, (b) the “rules” about how ownership interests are treated, and (c) the “rules” about how monies will be distributed that come from dividends or a sale of company interests, all without notifying all of the other owners, including you. Ouch!

You won’t locate that expressed clearly in the legal papers, but it commonly comes about because (i) the legal papers say that majority rules in such matters, and (ii) there will be no provision in the legal papers that says “All owners must be told of all changes.”

For this reason, to the extent that you will be able to get at least some of these provisions in your superseding addendum, you need to have in that superseding addendum a provision we commonly call a “No Unsigned Changes” provision. Such a provision provides that nothing in your superseding addendum – the terms and conditions of your two different relations, employee and owner – can be changed unless you sign it.

Want to see the kinds of words and provisions you may need? Consider out “Model Memo and Addendum Responding to an Offer of Employee Ownership from a New or Young Company.” A unique and sophisticated model to gain significant protections to both your employment and your equity. “What To Say, and How to Say It.”™ To get your copy just [click here.] Delivered by Email – Instantly!

An ultimate question remains: Do you have the leverage to get these provisions inserted by negotiating with your company? The question will be answered in the affirmative, if you are viewed by company management to possess truly unique and special “human capital,” and you won’t ever find out unless and until you try.

But better you get at least one or two of these provisions than none. And even if you get none, better that you know “where you stand,” because if you know “where you stand,” you will be better prepared to deal with your employer if and when a risk “comes at you” or, more likely, threatens your valuable ownership interests.

P.S.: For individual attention and assistance, I am available for telephone consultations lasting 30 minutes, 60 minutes, or 2 hours. If you would like to set up a consultation, just [click here.] [newjob]

SkloverWorkingWisdom™ emphasizes smart negotiating – and navigating – for yourself at work. Negotiation and navigation of work and career issues requires that you think “out of the box,” and build value and avoid risks at every point in your career. We strive to help you understand what is commonly before you – traps and pitfalls, included – and to avoid the likely bumps in the road. For those considering seeking or accepting stock or units in their company a part owner of a start up company, thinking “a long way down the road” is especially important.

Always be proactive. Always be creative. Always be persistent. Always be vigilant. And always do what you can to achieve for yourself, your family, and your career. Take all available steps to increase and secure employment “rewards” and eliminate or reduce employment “risks.” Making sure you are taking advantage of all employment benefits and perquisites available to you is one way to do just that. Learning the “tricks of the trade” is what SkloverWorkingWisdom™ is all about.

*A note about our Actual Case Histories: In order to preserve client confidences, and protect client identities, we alter certain facts, including the name, age, gender, position, date, geographical location, and industry of our clients. The essential facts, the point illustrated and the lesson to be learned, remain actual.

Please Note: This Email Newsletter is not legal advice, but only an effort to provide generalized information about important topics related to employment and the law. Legal advice can only be rendered after formal retention of counsel, and must take into account the facts and circumstances of a particular case. Those in need of legal advice, counsel or representation should retain competent legal counsel licensed to practice law in their locale.

Sklover Working Wisdom™ is a trademarked newsletter publication of Alan L. Sklover, of Sklover & Company, LLC, a law firm dedicated to the counsel and representation of employees in matters of their employment, compensation and severance. Nothing expressed in this material constitutes legal advice. Please note that Mr. Sklover is admitted to practice in the state of New York, only. When assisting clients in other jurisdictions, he retains the assistance of local counsel and/or obtains permission of local Courts to appear. Copying, use and/or reproduction of this material in any form or media without prior written permission is strictly prohibited. All rights reserved. For further information, contact Sklover & Company, LLC, 45 Rockefeller Plaza, Suite 2000, New York, New York 10111 (212) 757-5000.

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