A brief summary of what Conditional Shares are, how they work, and when to use them.
Conditional Shares are actually fairly simple. They are shares that are issued under certain conditions (Key Performance Indicators, or KPIs) that the recipient has to meet. Don't worry, all of this is explained in more detail further down. First, some context might help:
The reason Conditional Shares are so useful is that they reduce the risk for both parties: the giver of shares (often the Founder of the business), and the recipient, who we'll call Joe.
To explain the risks, here are some less balanced alternatives, both of which begin with the Founder promising Joe 100,000 shares in exchange for Joe delivering on certain milestones that year.
The Founder promises to give Joe the shares at the end of the year
If Joe delivers and the business has grown in that year because of all of his efforts, he now has a higher Income Tax liability on receipt of the shares than he would if he had received them upfront.
The other, not so uncommon, issue with this approach
Joe holds up his end of the deal, but for whatever reason, the Founder can't (or won't) give him the shares. Since no agreement was signed, there isn't much Joe can do and his effort has gone to waste.
The Founder gives Joe the shares upfront
If, a year later, Joe hasn't done what he promised to do, he still holds a chunk of equity in the business. There's not much the Founder can do without spending time, money and effort to get them back.
The Solution: Conditional Shares
Conditional Shares offer a greater level of protection for both parties due to the "Task Agreement" that's legally bound to the distribution. This explains what Joe needs to do to remove the conditions from - and keep - the shares.
How it works is that once Joe accepts the agreement, he receives the 100,000 Conditional Shares. However, they are effectively worthless until Joe meets his KPIs and the Founder vests the shares.
As Joe continues to meet his KPIs, more shares vest and he gets rewarded for the value he's added to the business.
If some of the KPIs are not met, the agreed proportion of Joe's shares are Deferred (effectively cancelled).
There are a couple of things for the parties to define upfront:
Key Performance Indicators
There are some basic rules to keep in mind when deciding upon these Key Performance Indicators (KPIs). They should be:
These could be as simple as time contributed over the initial years, or more specific and tangible like securing a certain investment, building a certain functionality, or meeting sales targets.
Vesting timing and criteria
In the case of Conditional Shares, vesting actually means the removal of conditionality. The shares that do not get made unconditional (do not vest) can be Deferred (effectively cancelled).
This vesting can happen over time, or as certain sub-milestones are met within the broader specified delivery. The thing to decide at this point in the process is exactly how many shares can vest each time a sub-milestone is met, or a given amount of time passes.
The process can be taken further by setting up an Agile Partnership, which combines Conditional Shares with Growth Shares. The Agile Partnership process is more complex, especially for more mature businesses, so get in touch with a member of our team at firstname.lastname@example.org to book a call.
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