Unit 3: Safeguard your equity commitment to optimize impact

[Alicia_Schmidt]

After you determine your desired equity pledge model, you will want to review the following considerations to safeguard your equity commitment to optimize its impact. 

1. Outline plans for change of ownershipLock in at least .01% upfront
2. Take action to minimize social impact dilution
3.  Ride the upside of your stock (scheduled sale)
4. Avoid stock volatility
5. Leverage the simplicity of a corporate Donor Advised Fund (DAF) 

Outline plans for change of ownership

If you are many years away from an exit (early or growth stage) and/or believe you are an acquisition target, it is especially important  to outline plans for a change of ownership in your Board Resolution (and warrant agreement if applicable). Consider the following:

1. Factor your likely exit into your equity model selection.

If you believe your likely exit is an acquisition, we recommend the Corporate 1% Upfront Model because it’s the best way to 100% protect your social impact legacy (warrants are legally binding).

2. Take steps to preserve at least 45% of your social impact commitment. 

Regardless of the model you select, we suggest that you take steps up front to ensure your desired outcome.  Most companies seek to preserve 100% of their social impact commitment.  If it’s not feasible, we recommend that you establish a floor of preserving at least 45% or your social impact commitment.  Formalize this by including it in your warrant agreement and/or Board Resolution.

You might also want to think about how long the social impact fund will exist post-acquisition and who will have control over directing the social impact funds.  This can also be decided later.  

Corporate 1% Upfront Model

Corporate 1% Distributed Model

Clearly define treatment of warrants at acquisition. The Pledge 1% standard warrant templates (most commonly used) specifies  that, at the time of an acquisition, 100% of the warrants are immediately exercisable.  If this is not feasible, we recommend that at the very least, 45% of the warrants become immediately exercisable, so that 45% of the original social impact legacy would be preserved.  You might also want to include language in the warrant agreement and Warrant MOU directing your philanthropic partner how and when the charitable proceeds from the sale of the warrant shares should be allocated after acquisition. Do not include a “vesting” period for warrants.  We recommend that 100% of the warrants be exercisable at the time of a liquidity event.

Clearly define the treatment of outstanding social impact shares at acquisition. If possible, we recommend that the Board Resolution approving the issuance of shares for social impact, include language which commits to the following in the event of an acquisition: Remaining portion of the originally reserved social impact shares (or the current value thereof) will continue to be issued on the original schedule to the philanthropic partner for distribution to charitable purposes. If it is not practical to continue this over the remaining portion of the X-year period, a minimum of 45% of the total originally reserved social impact shares will be transferred at the time of the acquisition to the philanthropic partner (likely 0.1% at time of Board Resolution and another 0.35% at exit). There may be some circumstances in which this is simply not feasible. At the end of the day, we want this to be a positive and happy element of your M&A outcome.  It will be up to you and your Board to figure this out at the time of the acquisition; however, we suggest you have something about this in your Board Resolution and/or MOU Establishing DAF if possible.

Lock in at least .01% upfront

Regardless of which corporate model you select, we strongly recommend that you transfer to your philanthropic partner/corporate donor-advised fund, and/or make exerciseable at least 0.1% of your equity at the time of your Board Resolution. You may want to consider a higher number and/or initiate the annual transfers pre exit (see the Lookout case study).  Your .1% upfront can be achieved via a Warrant Agreement that becomes exercisable upon a liquidity event or via a stock transfer agreement, that transfers the shares to your Philanthropic Partner right away. The benefit of the warrant is that they are non-voting shares. 

This will ensure that no matter what happens, some level of social impact legacy will be preserved.

Take action to minimize social impact dilution

This is particularly relevant for early- and growth-stage companies. By locking in your social impact commitment early, you’ve demonstrated to your employees, future employees, partners, and customers your company’s core values and culture. But, as you raise subsequent rounds of funding, your social impact legacy could be diluted.

There are a few actions you can take to avoid this:

• Topping off: We recommend that at the very least, you discuss “topping off” with your Board at the time of your commitment. “Topping off” is simply setting aside additional equity pre exit so that your social impact commitment once again equals 1% of your fully diluted shares. If possible, we suggest that you include in your Board Resolution  an “intent” to top off either right before your IPO (or with each subsequent funding round). However, if this adds too much friction, we suggest that you focus first on simply getting the equity pledge done. If needed, you can always address this later.
  
  
• Anchor your 1% social impact commitment on the number of outstanding shares at IPO: Quite candidly, we have not seen this approach applied yet. However, for you pioneers out there, you could specify in your Board Resolution that the 1% for social impact will be calculated based on the number of fully diluted shares at the time of your IPO rather than at the time of the Board Resolution. Note that this primarily applies to those selecting the Corporate 1% Distributed Model. 
  
  

Ride the upside of your stock (scheduled sale)

If you believe that it’s likely that your stock price will rise over time, post IPO, we recommend that you spread the sale of your shares and/or warrant shares over a period of 5 to 10 years.

Most warrant/DAF agreements will require you to include this “scheduled sale” in the signed agreement.  This is important because, as a matter of policy, most DAF providers are required to sell all shares immediately following the lock up post exit unless otherwise specified in the legal agreements. Note - even though there is a “scheduled sale,” it’s still common practice for the warrants to be immediately exercisable post exit to protect the social impact legacy. 

Avoid stock volatility

Consider pre-setting the first sale of your social impact shares to a date other than the end of the lock-up period i.e. 1 year anniversary of your IPO or 2 months after the lock up.  

Typically, as a matter of policy, most philanthropic partner/donor-advised fund provider, are required to sell the shares as soon as they are able to do so, unless you specify otherwise in your legal agreement. If you want to avoid any stock volatility that may occur in conjunction with the end of your lock-up period, it’s important for you to be specific in your warrant agreement and donor-advised fund MOU about your desired sell date (the initial date, the “scheduled sale” over a number of years, and any conditions that should trigger a change).  These terms are extremely difficult, if not impossible, to change at a later date. 

Leverage the simplicity of a corporate Donor Advised Fund (DAF) 

For most Pledge 1% member companies, a corporate DAF is the preferred avenue for setting up a social impact fund.  DAFs are much easier to create and manage than a foundation. The DAF provider takes care of all administration (audits, nonprofit validation, reporting, etc) so that your team can focus on impact. DAFs also enable you to keep the social impact (and your social impact employees) integrated in your core business. Foundations have greater restrictions here.

Pledge 1%’s preferred philanthropic partner for U.S. Corporate donor-advised funds is Tides (with the exception of Boston and Colorado). Tides has worked with numerous Pledge 1% members (Twilio, Okta, Upwork, PagerDuty, Box, etc) and is very familiar with the Pledge 1% equity models as well as our member needs.  The Boston Foundation, The Community Foundation of Boulder County, Rose Community Foundation, and The Denver Foundation have also worked very closely with Pledge 1% to support members in their regions. That said, Pledge 1% is happy to partner with any philanthropic entity that you select. 

Note: Similar to foundations, donor-advised funds cannot be used for internal operating expenses or marketing activities that benefit your company. In addition to a DAF, most corporate social impact programs will also have an annual operating budget (similar to other departments within your company). 

Consult Tax Advisor / Accountant

Regardless of the Equity Model you select, we recommend that you consult your corporate accountant and/or personal tax advisor for confirmation of tax implications.  We’ve observed that for most companies and founders, tax considerations rarely drive the decision to pledge equity and/or the selection of the optimal model, however, maximizing tax benefits is never a bad thing. 

For Founders, it’s worth noting that if you select the post-exit model, and execute a legally binding Founder pledge agreement, per Deloitte Tax Memo you will be able to take your tax deduction in the year that your exit occurs and/or you transfer the shares, not when you execute the pledge agreement.

---

> NEXT: Rally your board