Even if We’re Just Dancin’ in the Dark… We Should Still Understand the Equity Repurchase Rights

by John Ludlum

It is common for employees and executives of technology companies to receive a significant portion of their compensation in equity. For executives, the equity often represents the majority of the financial upside of the relationship. Years ago, business practices were more relaxed in Silicon Valley and other technology-favorable business environments with terms like single trigger vesting acceleration baked into equity plans for a change of control, and equity repurchase rights for the company were often quite limited.

Times have changed. While it is fair to say that sometimes terms like single trigger change of control acceleration resulted in unfair windfalls for employees who received equity awards shortly before a change of control, especially during economic cycles where valuations were volatile (rapid value increases for the common stock of private companies seem to go in cycles), there are now several considerations for executives to think about in connection with the likely value of their equity in an employment opportunity.

Most companies have equity forfeiture terms in their equity documents for cause terminations (this has been market for quite a while), but additional forfeiture terms now are found linked to restrictive covenants—go to work for a competitor or violate a non-solicitation term and potentially forfeit your equity. In addition, most companies have a company right to repurchase vested shares delivered through restricted stock awards, option exercises, or other equity transfers that applies on termination of employment including without cause. While these repurchase rights are typically at fair market value for terminations without cause, they still operate to limit the executive’s upside on the equity because it is not possible to hold the shares until the eventual exit if the company chooses to repurchase them prior to the exit. The company’s argument for these repurchase rights is that the executives receive the appreciation value for their periods of service and should not be allowed to benefit from the full value at exit. There are, obviously, two sides to that position, which is a business point to negotiate.

Another issue to watch for, which most often comes up for private equity-backed companies, is the repurchase valuation. If the price is set under a “reasonable” standard, the price should not be less than objective indicators (arm’s length transactions) of the price per share. However, there are limited restrictions on the board’s ability to determine a repurchase price that gives substantial discounts for lack of marketability and minority shareholder positions. In some agreements, executives deal with this term by specifying an outside valuation for the repurchase, such as the 409A independent valuation if the company has one, or even pursuant to an outside valuation engaged for the purpose of the repurchase with procedural specifications for how the outside firm is selected.

Remember to read the repurchase terms and pay attention to the valuation process when considering the value of private company equity.