Founders’ Equity: Key Considerations for Israeli-Related Tech Startups

In the dynamic ecosystem of Israeli tech startups, equity arrangements for founders are a cornerstone of the company’s long-term success. Whether your company is structured with a parent entity in Delaware or Israel, understanding the nuances of founders’ equity is crucial, especially when some or all the founders are initially based in Israel.

Founders’ Stock and Vesting Schedules

Founders’ stock typically comes with a vesting schedule, ensuring that founders remain committed to the company over a set period. Vesting periods usually range from 2 to 4 years, with 3 years being common for founders. This means that a founder earns ownership of their shares over time, with a portion of the shares becoming vested at regular intervals.

It’s important to note that the vesting period is just one aspect of the equity arrangement. Not all of a founder’s equity might be subject to reverse vesting. In cases where founders have invested significant time or resources into the project before the company’s formal establishment, a portion of their equity might not be subject to vesting at all. This recognizes the early contributions made by the founders and is often a point of negotiation.

We strongly recommend that Israeli founders, particularly those involved with U.S.-based parent entities, enter into reverse vesting arrangements at the ideation stage, even before the company is officially formed, or closely thereafter. Establishing these terms early may be helpful for their tax positions and the 83(b) election filing, as noted below.

Acceleration of Vesting: Key Events

Vesting acceleration is an important concept that comes into play during certain key events. Common triggers for acceleration include the death or disability of a founder, termination without cause, resignation for good reason, and other significant events.

In the context of a merger or acquisition (M&A), it is often expected that all unvested equity will accelerate and become fully vested. However, some investors prefer a double-trigger mechanism, where acceleration occurs only if the founder is terminated by the buyer post-M&A. This approach ensures that the founders are incentivized to remain with the company through the transition.

It’s crucial for founders to understand that reverse vesting arrangements are not only a matter of negotiation with investors but also a critical issue among the founders themselves. The terms of reverse vesting can significantly impact the relationship between founders, particularly if one founder leaves the company early or if there are changes in the founding team. With the consent of a majority of the remaining founders, acceleration may be limited depending on the specific circumstances. Therefore, founders should regard reverse vesting as an essential aspect of their internal agreements, not just a provision driven by venture capitalists.

These arrangements are highly commercial and can vary significantly depending on the deal, the founding team, and the investors involved.

The 83(b) Election and Cross-Border Tax Considerations

The 83(b) election is a tax strategy that allows founders to avoid paying taxes as their equity vests and instead pay taxes on the value of their stock at the time it is granted, which is often much lower if the election is made close to the company’s formation. By doing so, founders can potentially pay lower taxes upfront and then benefit from capital gains tax treatment when they eventually sell their shares, rather than paying ordinary income tax on the value of the shares as they vest. Almost all U.S. founders make 83(b) elections for these reasons.

While this strategy may not seem intuitive, we recommend that Israeli founders, even those who are not currently subject to U.S. taxes, consider making an 83(b) election as well. This can be particularly important for those who might eventually relocate to the U.S., as it helps mitigate future tax exposure and avoid complications that might deter potential new investors..

We recommend considering filing the 83(b) election immediately after the formation of the company, particularly for U.S. companies, typically Delaware entities. The election should reflect the reverse vesting terms agreed upon in the founders’ agreement and the value of the shares as of the company’s formation. Even for Israeli founders who are not U.S. persons, making this election can mitigate future tax exposure or avoid the need to cancel reverse vesting arrangements.

However, founders of Israeli-related companies must consider both Israeli and U.S. tax implications. For example, the effects of contributing intellectual property (IP) to their startups can differ significantly under Israeli tax law compared to U.S. tax considerations. The value of shares in the 83(b) election, particularly when attributable to IP assignment, may also have conflicting tax implications between the two jurisdictions. Each case must be reviewed specifically to address these complexities effectively.

It’s also important to note that extending existing vesting arrangements generally does not trigger tax implications, but this should be carefully reviewed in the context of each deal. Please be aware that this article does not constitute tax advice, and founders should consult with tax specialists to fully understand the implications of their decisions.

Conclusion

For Israeli founders and those involved in Israeli-related tech startups, whether under a Delaware or Israeli parent entity, understanding the intricacies of founders’ stock, vesting schedules, acceleration events, and the 83(b) election is crucial. These are not just legal formalities but essential components of your company’s equity structure with long-lasting implications. While these terms are highly negotiable and vary from deal to deal, getting them right from the start can help prevent disputes and ensure that all parties are aligned as the company grows.