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 will 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 does deliver, 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 up front.
The other, not so uncommon, issue with this approach is that 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 is not much Joe can do.
The Founder gives Joe the shares up front
If, a year later, Joe hasn't done what he promised to do, he still now holds a chunk of equity in the business. There is not much the Founder can do without spending time, money and effort to try to pull them back.
The Solution: Conditional Shares
Both parties are more protected, since there is a legally binding agreement signed up front that lays out exactly what Joe has to do, and how many of the shares he gets to keep if he only meets some of his KPIs.
The way it works, once the agreement is signed, is Joe gets the 100,000 Conditional Shares. They do not "Vest" (become unconditionally his), until both parties agree that the KPIs have been met. If some of the KPIs are not met, the agreed proportion of Joe's shares become Deferred (effectively cancelled).
There are a couple of things for the parties to define up front:
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 email@example.com to book a call.