Equity Donation for Early-Stage Startups

[Jan_DAlessandro]

Question

I’m an early-stage startup, and I want to take the equity pledge now. How do I pledge equity from day 1?

 

Answer

I always love this question — pledging equity early is one of the best ways to incorporate the idea of giving back into the foundation of your company. One of our founding members, Atlassian, took the equity pledge in the earliest stage of the company’s journey. As CEO and Founder, Scott Farquahar says, “it’s very easy to pledge 1% of zero.” Now their foundation has donated over $54 million to nonprofit causes.

More and more start ups are following Atlassian’s model, and setting aside equity to fund their social impact programs from the earliest stages. Even more exciting, more and more venture capitalists are encouraging their portfolio companies to take the equity pledge. Here's a list of Boardroom Allies from major venture capital firms who have committed to supporting their portfolio companies in pledging equity for social impact.  

At the end of this article, you’ll see additional resources,  including a general equity donation article, a deeper dive playbook, and a compilation of legal templates plus FAQs for your finance and legal teams. You may download the template board resolutions and documents that we provide, but will definitely need a lawyer to review any legal documents or board resolutions before executing them!

*Please note: You must consult your own personal and/or corporate legal and tax advisors before formalizing an equity pledge, as every founder and every company’s situation may be different.*

Here are some questions to ask yourself as a startup hoping to set aside equity early:

1. The Equity Source: Founder, Company, or Both?

You will want to decide if you will donate company or founder equity. Many early startups donate company equity. One of the benefits of pledging equity at this stage is that you have more control than ever over the allocation of company equity as you likely have only a handful of investors with voting rights, and maintain control of the cap table yourself! Setting aside company equity vs. founder also cements that this is a company cultural decision vs. an individual one. 

To formalize a set aside of company equity, you will first need to pass a Board resolution authorizing the shares that you would like to donate for issuance. Then, you will either (i) reserve the shares for future issuance to fund your social impact work and annotate that share reservation on your cap table, (ii) actually issue the shares and transfer them to an operating nonprofit or philanthropic partner who will open a Donor Advised Fund (DAF) for you (more on that later), or (iii) enter into a warrant agreement with an operating nonprofit or philanthropic partner who will open a (DAF) for you. You may download sample resolutions here. 

Founder equity can be useful if you encounter resistance from investors or are interested in potential personal tax benefits. You can even do a combination (ex. 0.5% founder, 0.5% company) of both founder and corporate equity! 

It is easy to donate personal shares directly to an operating nonprofit or philanthropic partner at your company’s early stages, and you won’t need board approval if you are not donating a major portion of the company’s outstanding shares. However, in order to maximize tax benefits, we recommend that rather than actually donating the shares to a nonprofit (or philanthropic partner that will open a Donor Advised Fund (DAF) for you, that you make a commitment to donate the shares after a liquidity event.   Here is a sample pledge letter for personal equity. 

*Please note: You must consult your own personal and/or corporate legal and tax advisors before formalizing an equity pledge, as every founder and every company’s situation may be different.*

2. The Mechanism: Warrants or Shares?

 Warrants are legally binding agreements entered into between the company and a specific recipient (i.e. an operating nonprofit or a philanthropic partner that will open up a DAF for you),  giving them the right to purchase shares in the event of a liquidity event (acquisition or IPO) at a nominal price.

Shares can be reserved for future issuance or pledged in a manner non- legally binding manner, or actually issued and transferred to a specific recipient in a legally binding stock transfer agreement. 

If you have a nonprofit partner in mind (an operating nonprofit, or a philanthropic partner that will open a DAF for you, then we strongly recommend that you formally issue and transfer the equity via a warrant or an actual stock transfer agreement vs. simply passing a board resolution reserving the shares for future issuance. Formally transferring the shares will preserve your social impact shares and keep your gift intact in the event of a major corporate change, such as an acquisition or leadership change.

Have a Nonprofit Partner? Consider a Warrant Agreement

If you do, a Warrant Agreement might be the best way to pledge equity as it is legally binding, BUT your ability to take a tax deduction occurs not when you enter into the warrant agreement, but when the warrant is exercised at the time of your liquidity event (acquisition or IPO). 

To issue a Warrant Agreement, you will need to determine a warrant holder. This title refers to the organization that will receive your donation, i.e. the operating nonprofit or philanthropic partner chosen by you. This partner can be a nonprofit organization that you wish to donate directly to, or a philanthropic partner that will open a donor-advised fund (DAF) for you.  The benefit of creating a DAF is that you will be able to take a tax deduction when you have your liquidity event, but will be able to recommend grants to be made out of your DAF over time, as you develop your social impact program.  If you do not have a philanthropic partner in mind, we have a network of partners to whom we will refer you to suit your needs, including the Tides Foundation, and many others. 

You may also transfer shares to an operating non-profit or philanthtopic partner that will create a DAF for you. The benefit of this is that your gift will be legally binding, but your ability to take a tax deduction occurs when you transfer the shares. If you are doing this very early in your company’s journey, it is less likely that you will be profitable and have the ability to take advantage of a tax deduction.  Thus, we recommend the warrant model for early - mid- stage companies. 

Haven't Decided on a  Nonprofit Partner? Consider the Shares Model

If you do not have a nonprofit partner in mind yet, that makes sense! You are still very early in your company’s lifecycle, and have much to think about. You can still set aside equity to fund your social impact program. In this case, you will want to use the shares reservation model. This model entails issuing a Board Resolution to reserve 1% of shares for future issuance for social impact, with a plan to actually issye and transfer the shares at a later date. A share reservation via board resolution is not legally binding, but a board resolution is still a strong commitment, and locks in your intention to build a social impact program. 

3. Donating LLC Interests

If your company is an LLC,  not a C corp, you can still donate LLC interests to fund your social impact work.  You may find a sample agreement HERE.

*Please note: You must consult your own personal and/or corporate legal and tax advisors before formalizing an equity pledge, as every founder and every company’s situation may be different.*

4. Topping Off

Whether you simply reserve the shares (or LLC interests) for future issuance, issue and transfer shares or enter into a warrant agreement with a philanthropic partner, the value of those shares will be diluted each time you raise a subsequent round of financing. To avoid that dilution, we recommend that you include in your initial board resolution the intention to top off the grant with each subsequent round of financing. 

Template Legal Docs

You may find template legal documents (i.e. sample Board Resolution, Warrant Agreement, Warrant MOU,  MOU Establishing DAF, LLC Pledge Agreement, Founders Pledge Letter. ) in The Companion Guide to the Equity Playbook for GCs and CFOs. You can also read more about donating equity in general in our CEO Equity Playbook.

Simply fill out this pledge form, indicating your interest in learning about the equity pledge in order to access these documents. 

Don’t forget: you will want to review any legal documents with your attorney and/or tax advisor before executing! 

Additional Resources

• Equity Donation General Overview - This article provides a high-level overview of equity donation and relevant questions to consider.
  
  
• The CEO Equity Playbook (Members-only access) - This playbook dives deeper into equity donation and features case studies from large enterprises (ex. Atlassian, SendGrid). It also includes strategies for discussing equity donation with your board. This asset is more designed for late-stage enterprises, but may be helpful for context.
  
  
• The CFO/General Counsel Playbook (Members-only access) - This document provides template legal documents for the models listed above and FAQs for your CFO and legal team.

• Case Studies and Other News -Subscribe to the equity tag on the resources page to get live updates of equity articles as they are published!