There are a number of legal documents startups should have drafted by a legal professional with expertise in the area of corporate transactions. Early-stage startups are well advised to protect their intellectual property, to be clear on their rules for corporate governance through carefully drafted bylaws, and to document terms for the issuance of securities to raise capital or manage contingencies if a founder leaves. While there are a number of documents that should be generated, and I plan to post a series of blogs on important startup documents, here are four key considerations for a stock purchase agreement.
Representations and Warranties. Both the seller and the purchaser will make certain representations and warranties that the investor possesses a requisite amount of information to make the purchase and the company is in good standing to make the sale. The representations and warranties for each party are contained in separate sections of the stock purchase agreement so it is clear as to the statements being made by each party. The list of what can be included in these sections is exhaustive and includes compliance with the law, government consents, employee benefits, product warranties, insurance, financial statements, and the party having the requisite authority and enforceability of the agreement itself. A party should not sign a stock purchase agreement if they cannot validly make the representations and warranties contained within the document.
Vesting Provisions for Founders. The most common vesting schedule takes place over four years and includes an equal percentage of stock for all founders in the amount of 25% accrued monthly. This means a founder would be fully vested after 4 years with the corporation. There are different ways to structure vesting. A “cliff” may be imposed where the initial 25% of the stock will vest on the one-year anniversary of the issuance date and on a monthly basis thereafter. Or, a founder who contributed significantly to the company prior to incorporation may receive a portion of shares vested up front. Vesting helps resolve issues that arise when a founder leaves a startup. It is also important to consult an accountant in regards to the 83(b) election that allows a founder to pay ordinary income tax rates on the fair market value of the stock at the time of the grant instead of on the vesting date.·
Repurchase Rights. This clause provides a party or parties the right to repurchase originally issued shares. Most often, it is the company that maintains the right to repurchase. The clause can be structured to give the company the option to buy shares back from a shareholder if certain event(s), detailed with specificity in the purchase agreement, occur. One example could be if the founder leaves the company early, the company will have the first right to choose whether or not to repurchase the shares. Also keep in mind that the repurchase rights of the company can be tied to vesting, where repurchase rights lapse after a period of 3-4 years.
Clarify the form of consideration. Is the stock being purchased with capital, property, or services? It is keenly important to clarify what value is being offered in exchange for stock, and what is permissible as consideration can vary from state to state. A stock purchase agreement should include how much stock is being purchased and the value of the stock being purchased. If the consideration is property, the board of directors will need to agree on the value of the property. This is also true for the value of services rendered to the company in exchange for stock.
These are just four different clauses, each with their own nuances and intricacies, which should be considered and possibly included in a stock purchase agreement depending on the parties and their goals. I am of the strong opinion that a sturdy legal framework helps promote the success of a startup. A couple additional notes; keep in mind issuing securities is subject to both federal and state laws so it is important to be apprised of securities regulations. Lastly, remember, the board of directors is responsible for authorizing and approving the issuance of securities so be sure to document these decisions with a board resolution approval form.