Background on Moonshot Award Practices
In the years leading up to the slowdown in the IPO markets in late 2021, it had become increasingly common for high-growth technology companies to grant large equity incentive awards to their founders and/or CEOs in the lead-up to a public listing or, in some cases, after the company went public. These awards, which are often referred to as “special value creation,” “mega,” or “moonshot” grants, were frequently tied to achieving aggressive stock price milestone targets, with the rationale that the market price–based performance condition aligns incentives between the company visionary and the company’s stockholders around driving exceptional increases in stockholder value, with the executive realizing value only if the company’s stockholders benefit from substantial value creation.
Musk Moonshot Award and Litigation
Tesla granted a “moonshot” award to Elon Musk, its founder, chair, CEO, and “Technoking,” in January 2018. Musk’s award represented the largest equity award ever granted to a public company executive, anticipated to have an approximate value of $55.8 billion if the applicable performance criteria were achieved (which would have resulted in, among other things, an increase in Tesla’s market capitalization by $600 billion) and covering up to 12% of the total outstanding shares. The award was subject to 12 equal performance-based vesting tranches, each requiring an increase of the company’s market capitalization by $50 billion and the satisfaction of certain revenue or EBITDA targets.
In June 2018, a stockholder sued the board and Musk for, among other things, breaches of fiduciary duty, unjust enrichment, and waste. The case went to trial in November 2022, and, in January 2024, the Delaware Court of Chancery ordered the grant rescinded in full after finding that the grant of the moonshot award was tainted by improper approval processes and had not been shown to be entirely fair to minority stockholders. We expect Tesla will appeal the decision to the Delaware Supreme Court, which could overrule or modify the decision (or aspects of it).
Overview of Chancery Court Opinion
In a 201-page Post-Trial Opinion, delivered over a year following trial, Chancellor Kathaleen St. J. McCormick sided with the plaintiff in a derivative suit against Tesla (as the nominal defendant) and several current and former members of its board of directors. In doing so, Chancellor McCormick found that awarding the moonshot grant to Musk was a “conflicted-controlled transaction” as a result of:
- His significant holdings of Tesla stock (approximately 21.9% at the relevant times)
- His status as a “Superstar CEO” with positional authority as chair, CEO, and founder, who was largely unconstrained by board control
- His extensive personal and financial relationships with Tesla’s board members
- The directors’ actions with respect to negotiating the grant with Musk
In describing Musk’s “Superstar CEO” status, the court noted his “unusually expansive managerial authority,” including that he:
- Specifically ignored board directives
- Made high-level decisions without seeking board approval
- Made high-level hiring/firing/compensation decisions “on a whim”
- Regularly utilized Tesla resources for projects at his other companies
Further, the court underlined that, following settlement with the U.S. Securities and Exchange Commission, he continued to make determinations on what was appropriate to tweet regarding Tesla with “desultory [board] enforcement” of the agreed supervision structure.
The court also found that the majority of the board, including the compensation committee, was not truly “independent” of Musk. In support of that finding, it devoted significant portions of the opinion to discussing Musk’s close relationships with his board members, which included his brother and several longstanding business associates and personal friends. Notably, a few of the board members were sufficiently close to Musk to have repeatedly vacationed with his family and others had earned what they characterized as “life-changing” or “dynastic” wealth from their investments in Musk’s companies and/or engagement as members of Tesla’s board.
The court also noted Musk’s significant control over the review and approval process for the moonshot award. The opinion concluded that Musk proposed the initial set of terms and all meaningful changes thereto; there was no adversarial negotiation over the size, performance criteria, or other aspects of the award; and he controlled when discussions and approvals of the award occurred (with meetings largely being scheduled or postponed on a highly rushed basis and with agendas and other items for consideration being changed or shared at the last minute). In one example of that control, the court noted that one of the biggest purported concerns the board expressed when considering the grant was their desire to keep Musk engaged in Tesla despite his significant time commitments at his other companies (including SpaceX, The Boring Company, Neuralink, and later, Twitter (now known as X)), and that the grant could have addressed this issue by requiring continued employment as CEO as a requirement for vesting, but that no one proposed that to Musk.
Collectively, the court found that the foregoing factors resulted in Musk having at least transaction-specific control of Tesla. As a result, the defendants bore the burden of proving that granting the moonshot award was entirely fair to Tesla stockholders, which is the highest standard of judicial review applicable under Delaware corporate law. In determining whether a transaction is entirely fair, Delaware law looks to whether there was both “fair dealing” (fair process) and a “fair price” (financial fairness). However, the final analysis of whether a transaction was fair is based on a holistic examination, rather than looking at bifurcated factors. Following the trial, the court found that Tesla was not able to meet this evidentiary standard and successfully establish that there was fair dealing or a fair price with respect to the moonshot grant.
Tesla’s counsel argued that, because the moonshot award had been granted subject to approval by a “majority of the minority [stock]holders,” the burden of proof should shift back to the plaintiffs. However, the court held that the stockholder consent was insufficiently informed and therefore did not shift the evidentiary burden because the disclosure materials did not apprise stockholders of all material information related to the transaction, including:
- Actual and potential director conflicts
- Flaws in the award’s review and approval process
- Likelihood of achieving the applicable performance criteria
In the entire fairness analysis, the court noted that Tesla did not undertake any benchmarking analysis with respect to the award—nor did it appear to consider either a lesser award or that Musk’s pre-existing stock ownership may have provided sufficient incentive for him to continue to grow the value of the company. Additionally, the court suggested that the board could have pushed for a commitment that Musk would remain Tesla’s CEO during the entire vesting period of the award (Musk’s prior award contained this requirement, but the new moonshot award instead required that he continue as either CEO or executive chairman and chief product officer during vesting). In addressing Tesla’s arguments that the performance milestones were sufficiently calibrated to warrant the moonshot grant, the court noted the criteria were achieved relatively quickly and that Tesla’s own internal projections indicated that several milestones were 70% likely to be achieved shortly after the grant was approved.
The court noted that the defendants maintained that the plan is an exceptional deal from a financial fairness perspective compared to compensation plans in portfolio companies backed by venture capital and private equity funds. However, the court stated that the defendants did not explain why anyone would compare a public company’s compensation plan with a private equity or venture capital compensation plan. It may seem obvious to practitioners and compensation advisors that public companies compete for executive talent with private companies (whether backed by private equity, venture capital, or otherwise), but the court did not make that connection—despite previously noting in its opinion that Tesla was competing with private companies SpaceX, The Boring Company, Neuralink, and, eventually, Twitter (now known as X) for Musk’s time and attention. Instead, the court said the defendants appeared to come up with the argument at trial, stating that they offered no theoretical justification for comparing the grant to venture capital or private equity compensation structures when Tesla is not backed by venture capital or private equity.
For companies that have executives who are (i) significant stockholders (holders of greater than 10% require special attention), (ii) “Superstar CEOs” (or exercise similar control/influence) or have important positions such as chair, CEO, and/or founder, and/or (iii) significantly personally and/or financially involved with board members (including if board members have substantial wealth tied to the company), we recommend working to ensure that the following factors are present when considering granting significant equity awards or other outsized compensation to such executives:
- Obtain benchmarking data from an independent compensation consultant to demonstrate that an award is appropriately sized for your company’s industry and peer group.
- If competition with private companies factors into the board/committee’s considerations, compensation advisors and counsel should ensure that the board/committee materials and minutes make specific note of this.
- Consider forming a special committee of the board’s disinterested directors that are most clearly independent of the award recipient (if not already comprising the compensation committee) and engaging independent compensation advisors and counsel to represent the committee.
- For this purpose, independence should not only be considered under applicable stock exchange requirements but should also involve a holistic review of historical professional, financial, and personal relationships with the award recipient, as well as the financial position and interests of the directors in the company.
- Provide committee members relevant materials to review prior to meetings, which should be scheduled with sufficient notice to members to permit thorough preparation.
- Draft minutes of each committee meeting that include more than cursory descriptions of the topics of discussions and pay particular care to any negotiations on an award’s size, key terms, and factors considered, as well as proposed alternative structures.
- The award’s size, performance criteria, and other terms award should be driven by the disinterested/independent committee or be the product of actual negotiation with the executive (rather than being set by the executive and passively accepted by the committee/board) and should consider your goals.
- Choose performance criteria that present a real risk of non-achievement (rather than metrics that are likely achievable early in the performance period).
- Where possible, provide alternatives to support fulsome discussion.
- The independent committee should consider the award’s purpose (for example, executive retention or stockholder value creation), whether the award supports those purposes, and whether there are alternatives to the award.
- For example, whether the executive holds sufficient equity such that a new award will not meaningfully impact retention or the executive’s alignment with stockholders.
- Company counsel, compensation advisors, and the board/committee should ensure that the board/committee materials and minutes fully reflect the information and factors considered when designing and approving the transaction.
- Internal and external counsel should exercise care in overseeing the process and in their communications regarding the grants. General counsel will often serve as a communications conduit with the award recipient during negotiations, helping the committee understand the recipient’s position or important technical aspects, as well as keeping the parties informed about timing and process matters. Counsel is advised to make clear that their communications serve those and similar purposes and that they are not advocating or appearing to advocate for the award recipient. Further, counsel will be well served to fully document the process and communications regarding award consideration and approval.
- Where stockholder solicitation materials include descriptions of these processes and communications, this documentation will aid in ensuring that they are described in all material respects.
- Structure any stockholder outreach efforts regarding compensation design to meaningfully engage on the substance of an award, rather than only soliciting positive feedback.
- When seeking “majority of the minority” stockholder approval, companies should ensure that disclosures provided to stockholders are thorough and complete and that all potential conflicts of interest are fully disclosed. If providing a description of the negotiation process, ensure that it fully reflects all material conversations/meetings relating to the negotiation. If describing director independence, be clear about the standard applied (for example, each director is disinterested and independent under the applicable stock exchange standard) and, ideally, describe factors considered when determining independence from the award recipient.
- Additionally, it remains important for companies to ensure that there is appropriate and meaningful board-level control on executive authority generally.
The holding of Tornetta v. Musk and its underlying reasoning (along with any rulings entered on appeal) will invariably have application outside of the moonshot award context and the specific facts of this case, as the court’s extensive analysis of the principles governing controlling stockholders will have applicability in a wide variety of transactions where general and transaction-specific control may be implicated.