Silicon Valley Self Regulation

Encyclopedia

An autodidact's delight

Encyclopedia

This is your one stop shop for any and all legal terms that most of us pretend to understand while signing an offer letter, but don't really know all that well.

409a valuation

A 409A valuation is a formal report that provides the value of a company’s common stock. This report’s name comes from Section 409A of the IRS’s Internal Revenue Code, which was created to eliminate any legal grey areas following the abuses of stock options by companies like Enron.

accelerated vesting

Accelerated vesting is a form of vesting that occurs at a more rapid rate than the rate defined in the company’s initial stock option plan vesting schedule. Accelerated vesting allows for option holders to receive the monetary advantage from their option much sooner than previously defined by the initial vesting schedule. This usually is conditioned on some event, leading many to refer to the scenario as “single trigger acceleration” if there is one event that causes the acceleration.

ACQUISITION

An acquisition is a transaction in which Company A gains a majority stake in Company B, while Company B doesn’t change its name or structure.

acquisition of assets

An acquisition of assets is a transaction in which Company A acquires the actual assets of Company B. This sort of transaction is common during bankruptcy proceedings, wherein Company A bids on the assets of Company B following Company B’s declaration of bankruptcy.

consolidation

A consolidation is a transaction in which both companies cease to exist, and a new company is created given that shareholders of each company approve the plan. Once the company is created, shareholders of the old companies receive common stock in the new entity.

double trigger

Double trigger acceleration, as you might have surmised after reading “accelerating vesting”, requires two conditions for accelerated vesting. Double trigger acceleration was designed to fundamentally protect employees from being terminated when the value of the employee’s unvested equity into the employee is greater than the cost of replacement in the event of an acquisition.

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EXERCISE WINDOW

An exercise window is the period of time defined by a company that an employee may sell their vested stock options upon leaving that company. For example, if your company has a ten-year exercise window, then you will be able to sell your stock options for ten years after you have left. If you have not sold those stock options within ten years, then you forfeit your ownership of those vested stock options.

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FULLY DILUTED SHARES

Fully diluted shares are the total number of outstanding shares if every potential means of conversion was exercised. Means of conversion refers to many things, like stock options and convertible notes.

GRANT

A grant is the issuing of something to an individual under the terms defined by the two consenting parties. If you have a stock option grant, this means that your company has given you stock options based on whatever terms you and your employer previously agreed to in defining the stock option grant.

INCENTIVE STOCK OPTION (iso)

An Incentive Stock Option (ISO) tax structure is a stock purchase plan that is developed by a company to provide employees with tax advantages and/or “built-in discounts” regarding stock ownership. This sort of plan can provide individuals with substantial potential gains, but it does come with costs. The tax rules associated with the exercise and sale of stock can be extremely tricky for an ISO.

initial public offering (ipo)

An initial public offering (IPO) is the first time that the public can purchase the stock of a private company. A company selects a firm to serve as underwriter, and that firm assists the issuing company in setting the type of issued security, amount of issued shares, offering price, and time to market.

LiQUIDATION PREFERENCE

Liquidation preference sets the order of payout for stakeholders in the case of a liquidity event. Put simply, liquidation preference establishes the “how much” and the “when” of your payout if you are a stakeholder in the company.

liquidity event

A liquidity event is an event in which individuals who hold stock in a company can “cash out.” There are many sorts of liquidity events, like acquisitions and IPOs.

lock-up period

A lock-up period is a defined time series when some select class of investors is not allowed to exercise shares. These are used to avoid liquidity problems while a company puts capital to work. In the tech ecosystem, lock-up periods are most common following an IPO. Lock-up periods are used in the days after an IPO to ensure that holders of the company stock don’t destabilize the new market with large liquidation events.

MANAGEMENT BUY-OUT (MBO)

A management acquisition, also known as a management-led buyout (MBO), is a transaction in which the executives of a company make it a private company by buying a controlling stake in the company. These sorts of acquisitions are less common, and are typically financed by mostly debt.

MERGER

A merger is a transaction in which the boards of directors of each company approve the plan, and then solicit approval from company shareholders. After approval, the acquired company ceases to exist and becomes a part of acquiring company.

mergers & acquisitions (m&A)

“Mergers and acquisitions” (M&A) refers to the different transactions that result in the consolidation of companies and/or assets. There are a number of transactions that make up M&A, like the following...

NON-QUALIFIED STOCK OPTION (nso)

A Non-qualified Stock Option (NSO) tax structure is a much more common and much simpler alternative to ISOs wherein employees pay income tax on the difference between the grant price and the exercise price. This employee stock option is called a non-qualified stock option because it doesn’t meet the IRS qualifications for an ISO.

NOTIONAL VALUE OF OPTIONS GRANTED

The notional value of something is the cumulative value of a position, including leverage and assets. Notational value is useful in understanding options. For example, imagine an option to buy 500 shares of stock in a company that is trading at $200 per share. The notational value of that option is $100,000 (200 x 500). 

pay to play provisions

“Pay to play”, specifically in the tech ecosystem, refers to a sort of provision that effectively punishes investors for not participating up to their full pro-rata percentage. These provisions come in a number of forms, from anti-dilutive formulas in a dilutive financing event to converting preferred stock to common stock if the investor doesn’t fully invest for their pro-rata ownership.

preferred stock

Preferred stock is an ownership stake that has a greater claim to assets of a company than other sorts of ownership stakes, like common stock. This means that anyone who holds preferred stock will be first in line once stockholders are able to collect dividends from a company. This sort of stock typically does not come with voting rights, and some preferred stock can be convertible (exchanged for a defined rate of common stock).

primary shares

Primary shares are stock that was issued for public sale by a private company (an IPO).

 

pro-rata rights

Pro-rata, in the tech ecosystem, refers to a type of investment right that allow an investor to participate in a subsequent round of funding that maintains the percentage of ownership that the investor currently holds in the company.

Right of first refusal (rofr)

“Right of First Refusal” (ROFR) is a contractual right that entitles a defined entity to the opportunity to take a defined action prior to any other outside entities being given the ability to bid for that action/business transaction.

secondary shares

Secondary shares, contrasted with primary shares, are newly issued stock offered in a ‘secondary offering’ that a company makes to raise growth capital or refinance.

STOCK OPTION

A “stock option” is the right to make a transaction, buy or sell, a stock at a defined price within a specified period of time. For an employee, “stock options” differ on the basis of maturity: your stocks “vest” as opposed to the option to buy/sell expiring within a specified period of time.

STRIKE PRICE

A strike price is the price at which an option can be exercised. This means that an option with a strike price of $200 can be exercised once the price of a share of stock in that company hits $200.

tender offer

A tender offer is a transaction in which Company A offers to buy the outstanding stock in Company B at a defined price. Company A makes this offer to Company B’s shareholders, not the management or board of directors. While tender offers don’t necessarily result in mergers, most tender offers do eventually result in merger events.

total cost to exercise

The total cost to exercise is the actual cost you would have to pay if you wanted to exercise your options at a given point in time. The total cost includes the cumulative costs of fees, tax withholding, the exercise cost, and other potential fees associated with that option as defined by the relevant parties.

VESTING

Vesting is the process by which individuals earn non-forfeitable rights to something, typically stock. This means that once you have worked at a company for a defined period of time, X, you will start to hold the value defined by the company in your offer. For example, imagine a company offered you 100 shares of stock as part of your compensation vesting over four years with a one-year cliff. This means that you will begin to accrue stock options after one year of employment (the vesting cliff), and that you will accrue an equal share of stocks over the remaining time, which is 25 shares for each year after the cliff.

VESTING CLIFF

A vesting cliff refers to the point in time at which your stock options will begin to vest. For example, you will begin to accrue stock options after one year if your equity compensation has a one-year vesting cliff.