USA Law and Practice Contributed by: D. Scott Bennett, Nicholas A. Dorsey, Virginia M. Anderson and Ellen H. Park, Cravath, Swaine & Moore LLP
ROFR and Transfer Restrictions Founders and other key holders of common stock are typically only permitted to sell their shares to a third party if they first provide the company and/or preferred stockholders with an ROFR to purchase the shares proposed to be transferred. Sometimes this ROFR applies with regard to proposed sales by preferred stock - holders as well. The company generally has the right to exercise the ROFR first and, if it does not exercise its right with regard to all of the shares proposed to be sold, the preferred stockholders have a right to purchase the remaining shares. In the event that any preferred stockholders do not elect to exercise their right in full, the partici - pating (purchasing) stockholders have the right to purchase the additional shares. If the com - pany and preferred stockholders do not collec - tively exercise their ROFR rights with regard to all of the shares proposed to be sold, then all of the subject shares may be sold to the third party (subject to any tag-along rights, as described later in this section). There are customary exceptions that generally apply to the application of the ROFR, including for estate planning purposes. Sometimes, growth companies also subject all of their common stock – or both preferred stock and common stock – to blanket transfer restric - tions in their by-laws. In the case of a blanket transfer restriction, customary exceptions will generally apply, including for estate planning purposes. There may also be a carve-out for transfers first subject to an ROFR in favour of the company. Tag-Along/Co-Sale Rights If an ROFR is not exercised in full by the com - pany and/or preferred stockholders, preferred
as large as possible in order to limit their risk of being diluted at a later point in time. Changes to the equity incentive pool often require approval of investors and so founders are motivated to have the incentive pool accurately reflect their hiring needs before the next equity financing, but nothing more (given that they and other exist - ing shareholders are ultimately the ones being diluted). Ultimately, an equity incentive pool equal to approximately 10–20% of the fully diluted post- money valuation of an early stage growth com - pany is typical. Founders’ Stock Investors may also demand that any stock held by the company’s founders that is not subject to vesting prior to their investment be subjected to a reverse vesting schedule (usually between three and four years, often with a one-year “cliff” and monthly or quarterly vesting thereafter) at the time of their investment. Under this arrange - ment, founders continue to hold their stock, but lose any unvested shares if they leave the com - pany before becoming fully vested. There are a handful of contractual exit rights and restrictions that are built into the NVCA form documents in order to provide some guardrails around secondary sales as well as facilitate exit opportunities that are supported by a critical mass of the existing stockholder base. In the recent, challenging exit environment, investors are even more focused on company growth strategies and exit plans (if any). However, the industry has not yet seen significant shifts in negotiated exit rights. 6. Exits 6.1 Investor Exit Rights
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