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What Should You Do With the Unvested Shares of Former Employees?

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In preventing and managing startup disputes, I’ve encountered some confusion among founders regarding unvested shares, specifically how and when to repurchase them. The answer is somewhat complex, so let’s start with the basics.

Oftentimes when early-stage founders (particularly first-time founders) think about equity, they think of granting stock options. This is not surprising. For many in the startup world, their only real experience getting equity is receiving stock options as an employee of a larger company. The reality is that most early-stage startups should be granting stock, and not stock options.

A stock option isn’t stock at all. It’s a right to purchase stock at a predetermined price (the “exercise price” or “strike price”). That price should be the fair market value of the stock on the date of grant.

Stock options are subject to regulations under Section 409A of the Internal Revenue Code. Those regulations are complicated and, if not followed, can lead to significant penalties. Failure to comply with Section 409A can pose diligence problems as well. The last thing you want to see is an investor or acquirer insisting that........

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