Common Mistakes & Case Studies
Learn from others' costly errors in equity-for-services deals
I have seen these errors repeatedly in my practice. Each one is preventable with proper planning. The case studies below are based on real situations (with details changed for confidentiality).
1Missing 83(b) Election
The 83(b) election must be filed with the IRS within 30 days of receiving restricted stock. Miss this deadline and you cannot file late - there are no extensions, no exceptions, no excuses.
- Deadline is exactly 30 days from grant date (not business days)
- Must be mailed to IRS (electronic filing not accepted)
- Copy must go to employer and be kept with tax records
- Filing late = permanent loss of the election
The $2.3 Million Tax Bill
A technical co-founder received 2 million shares of restricted stock at $0.001 per share when the company was worth almost nothing. He was busy building the product and forgot to file his 83(b) election. Four years later when the stock vested, the company had raised a Series B and the 409A valuation was $1.15 per share.
How to Prevent This
- Calendar the 83(b) deadline immediately upon grant
- Use certified mail with return receipt for proof of timely filing
- Company should provide pre-filled 83(b) form with grant documents
- Attorney or accountant should confirm receipt within first week
- Keep copies of filed election permanently
2No IP Assignment
If the service provider creates intellectual property but never assigns it to the company, the company may not own its core assets. This can kill an acquisition or funding round.
- Work-for-hire doctrine often does not apply to contractors
- Verbal agreements are difficult to enforce for IP
- Assignment must be in writing and should be signed before work begins
- Prior inventions should be disclosed and excluded
The Acquisition That Almost Failed
A SaaS company was being acquired for $15 million. During due diligence, the buyer discovered that the CTO (who had left acrimoniously 18 months earlier) had never signed an IP assignment agreement. His equity agreement covered vesting but had no IP provisions.
How to Prevent This
- Sign CIIA (Confidential Information and Invention Assignment) before any work begins
- Include IP assignment in the equity agreement itself as backup
- Require disclosure of prior inventions to avoid disputes
- Get assignment of moral rights where permitted
- Maintain chain of title documentation for all contributors
3Undefined Vesting Milestones
Milestone-based vesting sounds great in theory - earn equity by hitting goals. But vague milestones lead to disputes about whether they were achieved.
- "Launch the product" - what counts as launched?
- "Raise funding" - at what valuation? How much?
- "Get customers" - how many? Paying? Active?
- "Complete the design" - who decides it is complete?
The "Complete MVP" Dispute
A designer received 5% equity with 50% vesting upon "completing the MVP design." She delivered what she considered complete designs. The founders said the designs needed more work and refused to vest her shares. She sued.
How to Prevent This
- Define milestones with objective, measurable criteria
- Specify who determines completion (board, CEO, third party)
- Include deadline for completion and consequences of delay
- Consider time-based vesting instead for ongoing contributions
- Document milestone achievement in writing when it occurs
450/50 Deadlock Structures
Equal ownership feels fair at the start. But when co-founders disagree, 50/50 splits create deadlock - neither party can outvote the other, and the company cannot move forward.
- No tiebreaker for major decisions
- Neither party can be removed or fired
- Company may be forced into dissolution
- Investors will not touch 50/50 cap tables
The Two-Year Stalemate
Two co-founders split their company 50/50. After 18 months, they disagreed about whether to raise VC funding or bootstrap. Neither would budge. Board meetings became shouting matches. Key employees left. Potential investors walked away.
How to Prevent This
- Avoid exactly 50/50 splits - even 51/49 creates a tiebreaker
- Include deadlock resolution mechanism (mediator, buyout trigger)
- Define "major decisions" that require unanimous consent
- Consider vesting that adjusts based on relative contribution
- Add independent board member early for tiebreaking
5No Repurchase Rights
Without repurchase rights, a departed co-founder or contractor keeps all their vested equity forever. They become a passive shareholder with no obligations but all the upside.
- Departed founder holds blocking stake for major decisions
- Cap table becomes cluttered with inactive holders
- Investors want clean cap tables and may walk away
- No leverage to negotiate departure terms
The Passive 20% Holder
An early co-founder left after 1 year with 20% vested equity (4-year vesting, 1-year cliff). No repurchase rights existed. Five years later, the company was acquired for $50 million. The departed founder - who had contributed nothing for 5 years - received $10 million.
How to Prevent This
- Include call option on vested shares at FMV upon departure
- Require ROFR on any share transfers
- Consider "reverse vesting" where company can buy back over time
- Good leaver/bad leaver provisions affect repurchase price
- Lock-up provisions require holding through exit events
6Securities Violations
Issuing equity without a valid securities exemption is a federal crime. The SEC can require you to rescind the offering - meaning returning all shares and giving everyone their money back.
- No written equity plan in place before grants
- Exceeding Rule 701 limits without switching to Reg D
- Granting equity to fundraising consultants (prohibited under Rule 701)
- Missing state blue sky notice filings
The Fundraising Advisor Equity
A startup granted 2% equity to an advisor who helped them raise their seed round. During Series A due diligence, the VC's lawyers flagged the grant as a potential securities violation - Rule 701 explicitly excludes people who provide capital-raising services.
How to Prevent This
- Adopt a formal equity incentive plan before any grants
- Track Rule 701 aggregate limits (12-month rolling)
- Never grant equity for fundraising or investor introductions
- File state notice forms where required
- Consult securities counsel for non-standard grants
7Tax Miscalculation
Equity compensation has complex tax implications. Misjudging the FMV, miscalculating withholding, or misunderstanding the tax character of income can result in unexpected tax bills.
- Using outdated 409A valuation (must be less than 12 months old)
- Granting options below FMV (creates 409A penalty)
- Forgetting to update 409A after major events (funding rounds)
- Treating capital gains as ordinary income or vice versa
The 409A Penalty Disaster
A startup granted options at $0.10 per share based on a 409A valuation done 18 months earlier. The company had since raised a seed round at $2.00 per share. Years later, the IRS audited and determined the FMV at grant was $1.50 per share, not $0.10.
How to Prevent This
- Update 409A valuation at least annually and after material events
- Never grant options below current 409A FMV
- Document board reliance on 409A valuation in grant resolutions
- Use qualified independent appraiser for safe harbor protection
- Consult tax advisor on withholding obligations for equity grants
Summary: The Prevention Checklist
Before Any Equity Grant
Board-approved equity plan, current 409A valuation, securities exemption identified, recipient eligibility verified
At Grant Time
Signed CIIA, proper award agreement, 83(b) reminder, grant date documented, FMV recorded
Within 30 Days
83(b) election filed and confirmed, copy retained, employer copy provided
Ongoing
Cap table updated, Rule 701 limits tracked, 409A refreshed annually, state filings current
Every one of these mistakes is preventable with proper planning and documentation. The cost of doing it right upfront is a fraction of the cost of fixing it later.