Assessing the Fairness of Restricted Stock Offerings and Sweat Equity for Interns
Imagine you're a developer intern and an early-stage startup offers you 1000 restricted stock shares to work 20 hours per week for 6 months. This compensation model can be confusing and even risky, especially when the share price is based on the then fair-market value. Is this a fair deal, and how do you determine its value? Here, we will dissect this scenario and provide insights to help you make an informed decision.
Understanding the Share Offering
Your first step is to understand the context of the share offering. Here are two scenarios to illustrate the difference in value:
Scenario 1: 5,000,000 Shares Authorized, 500,000 Issued
In this case, you are offered 1000 shares out of a total of 500,000 issued shares. This means your shares represent only 1/500 of the issued shares. While this dilution seems minimal, it doesn't necessarily reflect the true value of your stake in the company.
Scenario 2: 5,000,000 Shares Authorized, 5,000 Issued
Here, the stake is much larger. With 1000 shares out of a total of 5000 issued shares, your shares represent 1/5 of the issued shares. This dramatic increase in your share percentage could significantly affect your valuation in the long term.
Key Considerations
While the specific details are crucial, it's important to understand that startups often carry a high level of risk. Here are some key factors to consider:
Understanding Capitalization Tables and Securities Law
Carefully examine the company's capitalization table, which shows the distribution of ownership and the number of shares outstanding. Additionally, familiarize yourself with securities law, which greatly influences how startups operate and protect their shareholders.
Another critical aspect is the ethical conduct of the founder. Don't assume the best of the founders; be wary of the potential risks and don't invest in a project you don't fully understand or trust.
The Value of the Offer
Evaluating the value of this offer is complex, especially when the share price is tied to the then fair-market value. Here are some steps you can take:
Research Company Valuations
If the company has undergone a Series A or B financing, it likely has a valuation through a 409A valuation. Request access to this document, as it provides an objective assessment of the company's value based on various financial metrics.
Seek Legal Advice
Consult with a legal professional specializing in startup law to understand the legal implications of accepting this offer. They can provide guidance on how to protect your interests and ensure the agreement is fair and legal.
Evaluate Non-Financial Factors
Consider the non-financial benefits of the internship, such as gaining valuable experience, networking opportunities, and potential future career advancement.
Conclusion
The decision to accept this internship offer requires careful consideration and a thorough analysis of the potential risks and rewards. It's essential to approach this situation with caution, seek professional advice, and fully understand the implications of accepting such an offer. Remember, the value of the restricted stock is highly dependent on the company's future performance and the broader market conditions, making it an inherently risky proposition.