Vesting: The Founders’ Friend
When founders are ready to grant founder stock, the vesting question naturally arises. The founder imagines a scenario where their company is sold and they are fired, and worries how their ownership would be impacted. A green founder might think that the solution is to make sure that their shares aren’t subject to any vesting. An experienced founder knows better.
Definition of vesting
Vesting is the bucket of terms that define how the founders will own their shares gradually over time. If the founder leaves before their shares are fully vested, the company typically has a right to repurchase the unvested shares (often at the lower of fair market value or the price paid). With vesting you usually consider the following terms:
- Total vesting period (4 years or 5 years)
- Vesting cliff (6 months or 1 year)
- Vesting frequency (monthly, quarterly, or yearly)
- Acceleration (if any, single or double trigger).
Myth: No vesting = no problems
Some founders think that they should NOT subject their shares to vesting. They may think that this is the advantage of being a founder. However, this is shortsighted; investors expect to see vesting. Also, it’s generally something that appeals to co-founders, who will be more likely to invest their time and energy in a project if they know everyone is in it for the long haul. If a fully vested CEO walks away, it’s going to be very difficult for the remaining founder(s) to pitch their company to investors and explain how an ex-employee owns 50% of the company.
Definition of acceleration
A founder can subject their shares to vesting, and also include terms for “accelerated” vesting. If a founder’s shares are subject to acceleration, then, under certain conditions, all or some of the founders unvested shares will immediately accelerate and become vested (owned) by the founder upon the occurrence of certain triggers.
Flavors of acceleration: Single vs. double trigger
Founder shares may be subject to either single or double acceleration. For single trigger acceleration, a single event, like a sale of the company, will trigger vesting acceleration. For double trigger acceleration, two events must occur, for instance, the sale of the company and the founder being fired, either without cause or for good reason (within a given period of time following the sale), to trigger the acceleration.
A word of caution about single trigger
Single trigger acceleration sounds great to most founders. They think to themselves, if I give myself single trigger acceleration, the moment my company is bought by another company, I will be fully vested, and I can quit and walk away with a full payout. However, when potential investors see single trigger acceleration, they think the same thing. An acquirer knows it may need to re-incentivize the founders with new equity, which can impact the company’s sale price and investor’s return. They prefer to see the double trigger acceleration flavor. (Your lawyer should be well-versed on the acceleration question, and is a great resource to help you wade through these murky waters!)
Myth: The terms can simply be renegotiated at financing
Why not wait for an investor to say, “I love your company, but I hate your vesting terms,” and revisit the issue then? Because, amending your founder grant at that point means you’ll not only pay legal fees, but you’ll open the door to renegotiating your entire vesting schedule and terms with your investors—at a time when your bargaining power may not be ideal. You’re about to get $5 million from the investor. You think you’re going to tell them no thank you, you’re not okay with that vesting term? It’s far better to set up a reasonable vesting schedule (which may or may not include acceleration) in the beginning, so that when investors come into the picture, they will be less likely to require amendments.
Click here to see this post.
This article was written by Kathy Nolan, Client Services Manager and a Corporate Attorney for Shoobx, Inc. Kathy works with the founders of hundreds of early stage startups and helps them use Shoobx to create incorporation, founder shares, financing, stock incentive plan, board consents, IP and HR documents, just to name a few. She also coaches startups on issues relating to Shoobx and due diligence management, working with counsel, 409a valuations, and employee option grants. Kathy is also a Corporate Attorney for Shoobx, and she was a legal fellow at the Boulder Trial Court and the Court of Appeals for the First Circuit in Boston. Kathy is a graduate of the University of Michigan Law School. She is on the Advisory Board of The Capital Network, a nonprofit that provides practical, hands-on education and personalized mentoring for founders as they navigate the fundraising process.
This article is for information purposes only and should not be construed as legal advice on any specific facts or circumstances.