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Stock Purchase Rights and Founder's Shares

A stock repurchase right with regard to a founder is a provision in a stock purchase agreement permitting the issuing corporation to  repurchase certain of the founder’s shares should she leave the corporation before an agreed minimum period of time has elapsed.   Venture investors tend to require that a corporation have such a repurchase right with founders as a condition to their investing.  They do this generally to align the founder’s risk with their own.

The Early Departing Founder

 Where there are multiple founders it can be in the best interests of founders to self-impose a repurchase right in favor of the corporation at the time of the startup’s organization –meaning well in advance of an outside venture investor requiring it.  While founders typically put in substantial time, effort and money before formally organizing the corporation, and this has value, it is also the case that the greater value is generally created by the founders working together after formal organization.  Because founders receive their shares at organization, however, a problem can arise if one of the founders decides to leave the corporation shortly after receiving her shares. 

Take, for example, a startup with three founders, each receiving 2.5 million shares upon organization.  Would it be fair for one of three to leave (or greatly reduce her involvement) months into the venture and yet retain one-third of the aggregate of all issued founder shares while the other founders continue to grind away full-time, without any meaningful salary  trying to execute the startup’s business plan intended to make those shares very valuable?  Possibly, but generally not.  So, in the absence of outside investors requiring it, it can be reasonable for founders to provide the corporation with the option to repurchase a certain percentage of a departing founder’s shares in order to protect the startup, encourage ongoing founder engagement, and reward those that stay for the long haul. 

 Repurchase Time Period and Percentage of Shares Subject to Repurchase

If one asks venture investors, they tend to prefer a repurchase right lapsing monthly and ratably over a four year period, although, generally, a three year period is probably sufficient.   The question then becomes as to what percentage of the founder’s shares does the repurchase right apply?  There is no “market” answer for this and each circumstance is going to differ.  However, with some guidance founders generally come to agreement by looking to the relative time, effort, and money invested by each founder as of organization, each founder’s industry record and importance to the corporation’s success even if in a reduced capacity, and the ongoing contribution anticipated from that founder if the venture is to succeed—and settle on a range of between 15% to 40% of a founder’s purchased shares being exempt from repurchase.  And these percentages can and often do vary among the founders in the same startup. Additionally, while the passage of time tends to be the predominant measure, is not the only factor that can drive the lapse of the corporation’s repurchase right.  Achievement of certain metrics, such as the realization of a fully functional beta-platform, may also come into play.

“Vesting” Accelerators: Events Triggering Early Termination of Repurchase Rights

There are two primary circumstance where the founders and corporation, or, as applicable, investors and founders, should acknowledge that the repurchase right will terminates early in whole or in part.  The first is a founder being pushed-out (fired) without “cause.”  While what constitutes “cause” is a negotiable item, the idea is if investors want a founder to leave in the absence of certain objective clearly articulated criteria, then the quid-pro-quo for the founder being denied the opportunity to “earn” the balance of his purchased shares through service is the corporation’s repurchase right terminating as to a material percentage of that founder’s shares.  That percentage, which can range up to 100%, should be sufficiently large to create an appropriate incentive for the investors to want to find an exit arrangement reasonably acceptable to all parties—the founder, the corporation, and the investors.  

The second circumstance is a corporate change of control—the acquisition of the corporation, or of a majority of its assets.  This is frequently, to a greater or lesser degree, the exit the corporation’s investors sought, which means the corporation and founder-employees will have a new group of decision makers at the top.  The founder protects himself with a provision in his stock purchase or, as applicable, repurchase agreement, that terminates the corporation’s repurchase rights over his shares in the event of a change of control.  This can be structured with a so-called a single trigger, meaning the repurchase rights terminate at change of control, or a double trigger, meaning if, after the corporation is acquired  the founder is subsequently terminated, made to move, provided with reduced responsibility, or some similar pre-identified event occurs, then the repurchase right ends.  In between is a combination of the two: upon change of control the repurchase rights terminates to perhaps 50% of the “unvested” shares owned, with the repurchase right lapsing to the balance according to the agreed schedule or the occurrence of a double trigger event.

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