This article was contributed by William W Eigner, Esq. & Brian Headman of Procopio, Cory, Hargreaves & Savitch LLP.
Subject Director And Advisor Shares To A Two-Year Vesting Schedule
Directors assume general corporate law fiduciary duties and potential liability from the very first day they serve on a company’s board. For this reason, independent directors expect to be compensated beginning day one. Highly sought after advisors expect similar rewards. Gradually vesting a director’s and advisor’s options align their compensation with their actual service while protecting the company in the event that they are prematurely removed from the board. In this circumstance, vesting only allows a short-lived director or advisor to receive the fraction of the option package that corresponds with the director’s or officer’s actual term of service.
Subjecting a director’s shares to a two-year vesting schedule also creates added performance incentive. By default, corporate directors are normally on a one-year term of service. Using a two-year vesting schedule encourages a director to perform well so that he or she is retained for a second term. Moreover, the two-year vesting schedule—as opposed to the four-year schedule typical of employee options—is preferred for directors because it magnifies the incentives for these influential individuals. Options issued to advisors are typically treated the same, so long as the advisor is not otherwise being compensated by the company.
Vesting should be accelerated in the event of a change of control. Many directors and advisors will not serve on a board if this provision is not included. If the board determines that it is in the best interests of the shareholders to sell the company, the directors and advisors should not be restricted from sharing in the value of the acquisition merely because their shares have not yet vested.
Check back Monday, October 1, for Rule of Thumb No. 4: Set a Lenient Post-Termination Exercise Period When Possible.