Founder Shares Vesting: Everything You Need To Know
It means that after a specified time period, a company founder may keep all or a certain percentage of his or her stock shares even after leaving the company.3 min read updated on February 01, 2023
Founder shares vesting means that after a specified time period or event, a company founder may keep all or a certain percentage of his or her stock shares even after leaving the company. Shares that are not vested may be repurchased by the corporation, often at a lower value than would be commanded on the open market. Vesting is designed to capitalize on the sweat equity of founders and determine that they are committed to the business for at least a few years.
When Does Vesting Occur?
Vesting clauses typically establish either a date or a specific event that triggers termination of the company's right of repurchase, which means that after this occurs the founder in question fully owns his or her stock shares.
Most commonly, after a full year of service to the company, 25 percent of the founder's equity is considered vested. Over the next three years, the remaining shares are vested monthly until all the holdings are vested. If the founder leaves the business during this time period, he or she receives only the vested percentage of shares. This four-year structure is standard, but companies can establish a range of structures in their founders' agreements.
In some cases, founders are vested right away for a portion of equity in exchange for the upfront work they did to establish the company. This percentage is typically 10 to 25 percent and is determined by the amount of sweat equity, the person's negotiations, and the current progress and status of the business.
Companies that are expected to grow quickly may establish a three-year vesting structure.
What Is the Purpose of Vesting?
This type of agreement reduces the risk for all founders by preventing one person from owning a large portion of the company and leaving after a year with his or her stock. In effect, the founder earns the right to keep his or her shares by committing to the company for at least three or four years. The corporation's right to repurchase the stock lapses gradually over time.
Establishing a vesting schedule can also be helpful with investor negotiations. Investors may be turned off by large portions of unvested stock and may insist on a vesting schedule before providing funds. You can head this issue off at the pass by having a reasonable vesting schedule in place before you court investors.
How Does Vesting Work?
The one-year cliff prevents a founder from keeping any of his or her stock if the business relationship ends before the corporation's first anniversary. If this occurs, the business can buy back all the founders' shares at the original price. For example:
- Bob gets 100,000 stock shares as co-founder of a business. He leaves right at the one-year mark.
- Because Bob's agreement establishes the standard vesting schedule, he gets to keep 25,000 of these shares.
- These shares are considered earned because of his 12 months of service.
- The company has the right to repurchase the remaining 75,000 shares at the pre-agreed price.
If a founder has to be terminated, he or she may be eligible to receive the vested shares he or she has earned thus far.
How Does Vesting Affect Voting?
Even though you don't own all your shares on day one as a co-founder, you are still entitled to voting rights for the unvested shares. The stock is considered payment for work you have yet to complete. Although you own it and can exercise its rights, it can be repossessed if you leave the business in the lurch.
What Factors Are Considered When Allocating Stock?
When determining the stock allocation and vesting schedule for a company's founders, the team will consider these questions:
- How much time did each person spend developing the business plan? Did one individual spend significantly more time than others?
- Has one or more individuals made a significant gift of intellectual property, such as a pending or issued patent or substantial work toward a patentable innovation?
- How many work hours will each founder regularly be devoting to the business? Is everyone full-time, or are some founders committed only part-time?
- Will founders be paid for their work and how soon will this occur?
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