Founder Vesting: Everything You Need to Know
Founder vesting or when the stockholder receives her stocks and can avoid being taxed at the capital gains rate, is a thing to consider when forming a business.3 min read
Founder vesting is one of the most important items to consider when forming your business. When any entrepreneur has a great business idea and wants to formally establishing his own company, he will need to educate himself on the do’s and don’ts, particularly when it comes to founder vesting. If he intends to create his own business and act as the sole business owner, then founder vesting isn’t nearly as important. But for businesses with more than one business owner, founder vesting provisions are not only beneficial, but necessary.
Vesting occurs when the stockholder receives her stocks and can avoid being taxed at the capital gains rate. Therefore, if you and your partner form a business, and the partner walks away a few months later, he can’t claim the stock since he hadn’t yet vested at the time he walked away from the business. Essentially, the idea of founder vesting actually protects the other business owners from one another so that they can focus on the larger goal of building and growing a successful company.
Founder Vesting Purpose
Founder vesting occurs when the business owners sit down and discuss the vesting period for their own respective shares in the company. Generally, the vesting period is between three to five years, depending on the size of the company and number of owners.
This is especially important for potential investors. Such investors can look at the initial formation documents and find out whether or not the stocks have a vesting period for the business owners. If there is no vesting period, investors might be hesitant to provide capital into the company. This is because any one of those business owners can simply walk away from the company and collect his or her shares without having to wait to vest. It simply wouldn’t be fair to the other shareholders, or the other business owners, if one of the business owner’s leave the company early on during the initial start-up stages.
In order to include rules surrounding the vesting requirement, the owners should put a provision in the operating agreement and other documentation indicating that all owners are subject to the vesting period, while also indicating how long the vesting period will last. Furthermore, the shares given should also indicate that such shares can only be collected after the vesting period has ended.
Additional language should be included in the provisions if applicable, including the following:
- What happens if a business owner is asked to leave, or is otherwise terminated by the other business owners
- What happens if a business is forced to sell its assets due to insolvency or bankruptcy
Founder Vesting Exception
An exception should be made to the founder vesting provision for when the company is sold to a new owner. Sometimes, the company simply has a hard time expanding and staying afloat financially. Therefore, if at any point during the vesting period the company is forced to sell its assets, additional language should be included in the provision stating that the founders and owners can still keep their shares while selling the company. This means that the owners can benefit from selling their shares to the new owner without losing out.
It might also be common for a business owner to be asked to leave before being vested. If this is the case, language should be included in the separation agreement as to what happens to that owner’s shares.
Vesting clauses are important to include during the initial formation, particularly during the financing stage. Since there is a delay between financing and actually operating, the vesting clause and provisions should be drafted as soon as possible to avoid potential issues of business owners leaving the company before it even begins operating. Without the vesting language, the business owner can walk away freely with his shares.
Remember that even if you form a business with a family member or friend, you should still include such provisional language in your formation documents from the beginning. Not only do you want all owners to be on the same page verbally, but you should ensure that the paperwork is agreed upon and signed by all owners to prevent legal issues down the line.
If you need help learning more about founder vesting, or if you need legal help drafting vesting provisions for your formation documents, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.