Meaning
Informal commitments to distribute equity or compensations that are not documented in writing create severe liabilities for a growing enterprise. For early-stage startups, unrecorded promises often emerge from casual conversations between founders and early helpers. These arrangements lack legal standing but cause severe conflict later.
Vague Agreement
Making these agreements typically occurs without board approval or formal written contracts. Over time, reliance on unrecorded promises leads to mismatched expectations among the team.
Corporate Liability
The financial risk of these informal agreements becomes apparent during a funding round or an acquisition. When a third party conducts due diligence, any mention of unrecorded promises can stall the transaction or force founders to allocate their own shares to resolve the issue. This creates a financial burden that falls directly on the early team, rather than the company as a whole.
Resolving these disputes often requires substantial cash payments or renegotiation of the original deal terms, which diminishes the returns for the actual shareholders.
Remedial Action
To prevent these issues, all equity commitments must be processed through formal board resolutions and written option grants immediately. It is cheaper to document an agreement today than to resolve a disagreement years later. Eliminating unrecorded promises ensures that the corporate capitalization table remains clean and attractive to future institutional investors.
