MY EMPLOYER OFFERED ME SHARES, IS IT A FAIR OFFER?

MY EMPLOYER OFFERED ME SHARES, IS IT A FAIR OFFER?

It is increasingly common in Southern California for employees to receive shares of their employers as a part of their compensation. This blog post is for employees at privately held companies who are receiving shares as part of their compensation and who are asking the question: what am I actually getting?

This can be a tough question, especially because some employees may not have the bargaining power required to demand access to all of the company’s records that would be required to determine the valuation of the company and the full information about their shares. To answer the question from a legal perspective requires –at the very least — a review of the company’s articles of incorporation, its bylaws, its capitalization table and a review of subscription agreements for any preferred shares issued by the company. Although any member of the public can order a copy of a company’s articles of incorporation, there’s only limited information in the articles. If it’s a private company that issued exempt securities in California, there may also be limited information here.

For an early employee or an employee with a lot of seniority, experience and bargaining power the answer is clear: demand the documents necessary to ascertain what is being offered. Everyone has seen The Social Network (or at least heard that some of the early employees at Facebook think they got screwed) and in Southern California, one should fear the sharks on land as much as the ones in the water.

In the worst instance I have seen, a client of mine was offered a third of the company. However, on review of the key documents, it became clear that her “Class C Restricted Shares” had questionable value at best. She would have no voting power, no dividends, and no representation on the Board. Essentially her sole right would be to participate in the spoils if the company was sold at an extreme premium and only then after the preferred shares had a couple of trips to the buffet line. It was the Rube Goldberg version of corporate law.

I’m a capitalist and on a certain level their offer to her was fair – no one expects an employee to have the same rights as people who put in the Benjamins that make things possible. But it was dishonorable to promise so much verbally and deliver so much less in writing. Information is power and I urged the client to take legal action, but she had been only been working for a short time and chose to walk away. Sometimes that is the right answer.

What if you are a later or more junior employee? Unfortunately, without access to the employer’s capitalization table and other key documents, it can be impossible to assess the value of your compensation package. If you are a much later employee, say the 150th employee, the answer is easy as well. You are probably slotted into a stock or option pool with defined rules. Although you can request an increase in the size of the package, unless you’re a rockstar, you won’t be able to deviate from the plan.

But what if you’re the 21st employee when things still remain a little fluid? The company has offered you a half million shares of restricted stock on a vesting schedule, but you have no idea beyond this what rights are associated with the shares or what stake of ownership it represents. You’re not a rockstar (yet), you just want to make sure that if the company prospers that you are lifted with the rising waters.

This is tricky. I’m tempted to tell you that you ought to demand the key documents discussed above and really that’s the only way to fully determine that you are not being screwed. However, I’m also aware that demanding too much could scuttle the offer for a junior employee. The company’s leadership may not want to disclose highly sensitive information that could cause tension between employees who perceive their value to be greater than what they are receiving (i.e. all employees).

There’s a couple of options for you at this stage.

First, add representations about the company’s capitalization into your employment agreement that match what your employer has told you verbally. For example, the company represents and warrants that twelve million shares have been issued and further issuances require majority approval. This is a suboptimal method, to be sure, but if it doesn’t represent the truth then the employer will be committing fraud by signing it. More often than not, it would assist you in ferreting out the truth. They may respond that the number is actually 12.9 million . . . or . . . did I say 12 million? What I thought I said was 112 million. The first is a hustler, the second is a liar. Decide accordingly.

The second option is what I call the email CYA. Often founders are making promises but not making any written agreements. This is sloppy and appropriately the subject of a different blog article, but for someone trying to accept a job so that they can move on and pay their own rent, what is most important is to memorialize the promise. Send an email that contains the verbal representations made about your stock compensation. If the email is not responded to, confirm it verbally next time you see your boss. Then send a second email that references the first email and the verbal confirmation in extreme detail (e.g. So great to chat with you on Thursday. I really liked the plaid jacket you were wearing and I hope your Mom’s birthday dinner at the Cheesecake Factory went as well as you had hoped. Thanks for confirming that my half a million shares currently represent xyz. It was interesting to learn more about how the company is financed.)

The third option for a junior employee may be to accept the offer with its flaws and vow to fight another day. The hard reality is that a lot of junior employees have limited bargaining power and can increase their bargaining power by taking the job and demonstrating superior performance. You may choose this option with some variation of the second option and what’s good for you is that once you’ve become an actual shareholder the law grants you certain rights to view corporate records.[1]

Caution: demanding shareholder records from your boss by citing California law is also tricky and calls to mind two proverbs. True, the squeaky wheel gets the grease. But, after you’ve made your bed, you must lie in it. No one likes to be threatened legally so I would couch your requests in the curiosity of learning more about the company and your future in it.

Conclusion

If you are an employee with leverage, nothing beats simply requesting an inspection of the documents you need. Offer to sign a confidentiality agreement to ease corporate concerns. If you are an employee without significant leverage, I’ve put forth options, which may improve your situation but should be viewed as suboptimal. You should consider requesting all of the documents. Asking probing questions of a prospective employer within a hiring process can be daunting, as it could arguably push that employer towards another candidate. On the other hand, a well-prepared employee or prospective employee who asks pointed questions may gain the respect of the employer and be well-received. And wouldn’t you rather work for that type of employer?

[1] Once you’ve become a shareholder, if it’s a California company, you would be entitled to obtain a list of shareholders and their shareholdings if: (1) you or you and a group of other shareholders who petition hold 1% of outstanding voting shares and have filed a Schedule 14A with the SEC; or (2) you or you and a group hold 5% of outstanding voting shares. Cal. Corp. Code §1600. Individual shareholders must request an inspection in writing. Cal. Corp. Code §1600. If the corporation fails to provide access to corporate records pursuant to the code, shareholders may petition the court for a writ of mandate, the court issue an order postponing previously noticed shareholders meetings, and recover attorneys fees if the court determines the corporations refusal to grant access was not justified. Cal. Corp. Code §1601; Valtz v. Penta Investment Corp. (1983, Cal App 4th Dist) 139 Cal App 3d 803.

These rights apply to California corporations, or a foreign corporation keeping its records in California, a foreign corporation having its principal executive office in California, and any pseudo-foreign corporation. Cal. Corp. Code §2115; Valtz v. Penta Investment Corp. (1983) 139 Cal. App. 3d 803.

If it’s a Delaware corporation, any shareholder may inspect corporate records upon a written request stating under oath that their purpose is “reasonably related” to their “interest as a stockholder.” Del. Gen. Corp. Law §220(b). The corporation may reject the request if it deems it to be improper, which permits the shareholder to petition the Delaware Court of Chancery to compel an inspection. For records other than the stock ledger or list of shareholders, the burden is on the shareholder to show a proper purpose. The Court may “prescribe any limitations or conditions with reference to the inspection, or award such other or further relief as the Court may deem just and proper.” Delaware courts have held that valuation of one’s stockholdings is a proper purpose. CM & M Group, Inc. v. Carroll, 453 A.2d 788 (Del. 1982).
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