Founders Shares: Everything You Need to Know
Founders shares are low-priced common stock issued when a startup company is incorporated. 3 min read
Founders shares are low-priced common stock issued when a startup company is incorporated. The shares are typically spread among initial parties, proportionate to their role or investment in the company. The shares are allocated at this point, but do not become vested, or owned, until a later time.
Shares for a startup company are often vested monthly, over a period of four years. The first 25 percent of shares are typically vested after the employee has passed the one-year cliff, meaning they have remained with the company for more than one year. When an employee leaves the company, vesting of the shares stops.
Although they are common stocks, founders may negotiate special vesting terms or other options as part of their agreement for venture investment. Since the stocks are issued to the originators of a firm, they do not typically receive any return until dividends are paid to all common stockholders. These shares are still entitled to all remaining after-tax profits, regardless of the amount.
The shares are usually issued for a nominal cash payment and/or assignment of intellectual property. Typically, founders shares are subject to a vesting schedule which gives the company the right to purchase the unvested shares back from the founder if they leave the company before their shares become fully vested.
Vesting Schedule in Founders Shares
The vesting schedule for founders shares should be agreed upon when the stock is first issued but may be decided at a later point, as a stipulation of the investment by an outside investor.
There are a few reasons a founder might agree to have their shares fall under a vesting schedule during the inception of a company.
- It is fairly common for some founders to leave a startup during the first few years, so the vesting schedule protects those who stay by eliminating the parties who leave from being able to reap the benefits of the employees who stay with the company.
- Having the expectation of future investments by the company; if the founder waits until after investors are involved, they may receive a stricter vesting schedule.
Often, founders may be given some vesting acknowledgment that is retroactively dated for the work they completed prior to the company becoming incorporated. Vesting provisions regularly include a safeguard for the employee being terminated without proper cause, as a result of the company being sold. When founders consent to such vesting limitations, it is typically good business practice to file special tax elections, which are recognized as Section 83(b) elections.
What Happens to Unvested Stock if the Company Is Sold
The vesting provisions for founder's stock might provide for speeding up of vesting after the sale of the company. There are a couple main variations of these provisions:
- A single-trigger provision, which expedites the vesting of shares that are not yet vested, effective at the time of the sale. With this provision, starting at the time of the sale, the buyer is responsible for understanding how to preserve and inspire the team members of the company that has been acquired.
- A double-trigger provision, which expedites the vesting of shares that are not yet vested, if the company is sold and the employee is fired without cause, sometime after the sale has closed. This type of provision protects the employee from being fired without cause by the buyer, by increasing the time of vesting for the existing shares that are not yet vested.
Vesting restrictions are not usually a part of the reasons why a company and a founder decide to go their separate ways. However, it is certainly a possibility that it applies in the case of being terminated without proper cause or voluntarily leaving the company.
Often, a founder may request a time reduction for vesting if they are terminated without cause, even when not in connection to a company acquisition. This may not be an entirely unreasonable request, but you should be very cautious about agreeing to an acceleration of vesting. This can become an issue if the person was terminated, but did not fully satisfy the definition of cause — they may end up walking away from the company with a large portion of the company's stock.
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