An Equity Incentive Agreement is a contract between a key employee and his or her employer, whereby the employer provides the employee with an equity interest in the company in order to motivate him or her to strive for high levels of on-the-job performance. The idea is that if the financial stake of the employee, generally a director, CEO, or other high-level executive, is tied closely to the financial future of the company, then that employee will have the incentive to work hard to meet the company’s financial goals. The package offered to an employee, as described in an Equity Incentive Agreement, will usually contain a mix of stock and stock options, carefully adjusted and fixed to company growth so as to adequately reward the employee for good performance.
For those drafting such agreements, it is important to include the following provisions:
1. Purpose. The purpose of the agreement, that being to motivate and reward the employee and permit the company to attract and retain able persons as employees, directors, and consultants, should be explained at the top of the agreement.
2. Definitions. Key terms should be defined in this paragraph. Such terms could include “annual incentive award,” “beneficiary,” “change of control,” “contribution agreement,” “covered employee,” “effective date,” “restricted stock”, and several others.
3. Plan Administration. The name of the committee that will be administering the equity incentive plan should be addressed. Generally the Board of Directors of a company will set up a committee for the purpose of administration of the plan. This provision should discuss who is on the committee or how it is comprised, the extent of the committee’s authority to adopt, amend, or rescind rules and regulations respecting the plan, and the limitations on the committee’s liability.
4. Stock Subject to Agreement. The overall number of shares of stock, the application of any limitations to grants of awards, the availability of shares not issued under those awards, and the exact type of stock offered should all be addressed in this section.
5. Exercise of Option. If the agreement provides for stock options to be awarded, it must cover the employee’s right and method to exercise.
a. Right to exercise. This provision should state for how long the option is exercisable and refer to a vesting schedule if applicable.
b. Method of exercise. This provision should state how the option is exercisable, be it by delivery of written or electronic notice.
6. Change of Control. The agreement should address what effect a change of control of the company, as defined within, would have on the agreement. Would the agreement still be in place? Would it be terminated? Might some provisions be accelerated? The agreement should address this scenario.
7. Entire Agreement / Governing Law. The final provision should state that the employee incentive plan is incorporated into the agreement by reference and that the plan and the agreement constitute the entire agreement of the parties with respect to the subject matter hereof, superseding in their entirety all prior undertakings and agreements of the Company and Optionee with respect to the subject matter addressed. The provision should also refer to the jurisdiction whose laws will govern the agreement.
These are some of the most important provisions found in Equity Incentive Agreements. Most importantly, the drafter will want to incorporate the Equity Incentive Plan by reference into the agreement, and carefully draft each provision to reflect the intentions of the parties.