The Importance of Founder Vesting
If you’ve done any homework or had any experience in the startup world, you’ll know that there are some industry accepted standards and rules of operation. There are generally accepted standards and guidelines for the investment process, for dividing up founder equity, for deciding how much equity or options to issue contractors and employees, etc.
One of those standards is related to vesting shares of stock or options. First off, it’s almost universally accepted that everyone will vest. Secondly, the vesting starting point is the 4/1 model, otherwise known as “four years with a one year cliff”…otherwise known as, it takes you four years of working continuously for the company in order to get access to all the equity you were promised, but you have to work one full year before you get that first chunk. Afterwards, you’ll get monthly or quarterly alotments as you work.
By the way, that last sentence describes vesting in a nutshell - the process of getting equity over a set period of time and in pre-determined incremental amounts.
The obviousness of why vesting is a thing is pretty clear. You don’t want to hand over a stack of equity that could be worth a stack of cash one day (that is the hope, right?) to someone who might do their work for the first few months and then flake out before the job is done. There are all sorts of common law and statutory contractual causes of action you could take them to court over, but the last thing a growing early stage company wants to do is file lawsuits left and right trying to force the return of equity they already granted over a job not well done. The obvious solution to this is to put a vesting arrangement in place. You will work for the company for an expected period of time, and in exchange the company will give you equity but spread it out over the time you’re working to make sure you either (a) stick around for how long we need you or (b) only get what you actually earned for the time you were here. This amount of time is often four years, but in the case of some contractors it could be much shorter if that’s what the job requires. Common sense should always prevail in determining the vesting time period.
But what about founders?
Here’s where the issue gets tricky - should founders be on vesting schedules? For most people, the answer is obvious….yes/no! And that’s the thing, people hold very strong views on both sides of the aisle and with logical reasons to back up their views. I’m of the “everyone should be vesting” camp and I’ll explain why.
The first and most important reason is that in life, shit happens. Everyone walks into a business with the plan of working day and night to make it the next big thing. Genuinely, truly have that plan. But then life happens. A visa issue arises. A baby appears and it’s no longer feasible to either work ridiculously long hours or do it for little to no money. Health issues come up. People just get burnt out and stop wanting to do what they’re doing. In my years working with startups, I’ve seen each of these issues come up on more than one occassion. Each time, most of my clients had listened to me and all the founders were on a vesting schedule. On a couple of occassions, they hadn’t and those are the only times there have been disputes about who should be given what and why.
With a restricted stock purchase agreement, especially the more standardized versions of the documents most people use, almost all possible problems are thought out and dealt with up front. No muss, no fuss. Everybody is in agreement on some basic terms - it’s gonna take 4 years to get your stock and you have to be working for the company on a level we all agree to during that time. If you stop, then you get no more shares.
Easy and simple.
So, what happens when everyone received all their shares up front, but one founder leaves? This is where a little “it depends” comes into play, because if there were additional documents or terms within the stock grant notice that act as claw back provisions, then there’s recourse. A clawback provision is fairly common in executive contracts and it makes it possible for the company to reclaim already vested shares of stock if the executive materially breaches the contract, does something negligent, etc. Otherwise, there isn’t really much you can do outside of trying to find grounds for a lawsuit and suing for the return of what should be unvested stock based upon some legal theory in contract law. However, if you’re unable to mount a lawsuit due to funds, or if you simply try and lose, you could end up with someone owning a relatively large percentage of your company who only worked there a few months and has nothing to do with the actual operation of the company ever again.
For these reasons, you will find that almost all investors will require that all founders (and often, all employees of the company period) be on vesting schedules for their stock. The last thing they want to do is drop hundreds of thousands, or millions of dollars into a company as an investment towards its profitable future, only for one of the key cofounders to walk away shortly afterwards and ride the wave to fortune and fame. Or, from the investor’s perspective, they don’t want one person to make it entirely more possible or likely that the company will not reach profitability because they just lost their ringer. Vesting may not keep everyone around for good, but it increases the likelihood of people sticking it out when they know that walking away will leave them with very little in the end. Some investors may require founder vesting to be restarted as a conditional element of the funding, but this doesn’t happen too often and can usually be negotiated away both in the very early stages (first year) and in the later stages, where you have people who’ve been putting in work for five or six years. Because of this, many founders simply put themselves on vesting schedules right from the beginning to protect one another from key persons leaving the company with a massive amount of equity ownership, while also putting the company in a position to be prepped and ready to receive funding.
But, this is why people like vesting and having the terms all laid out from day one. Everyone is aware of what can and cannot be done. Everyone is aware of when, how, and in what manner the equity is earned. Everyone is aware of what happens when you leave the company early - you lose all ownership rights to shares of stock you haven’t ‘earned’ through maintaining continuous employment with the company during the vesting period. Clean, simple, precise, and predictable.
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