Key Considerations for Structuring a Fair and Effective Founder Vesting Schedule for Your Startup’s Success
Starting a business is no small feat. As a startup founder, you’ve likely invested a significant amount of time, energy, and resources into building your company from the ground up. However, in the midst of all the excitement and hard work, there’s one aspect of startup equity that you may not have considered: founder vesting schedules.
Founder vesting schedules are a critical component of startup equity that can protect your business from risks, incentivize founders to remain committed, and allocate ownership fairly across the team. In this article, we’ll explore what vesting is, why it’s important for startup founders, and the consequences of not having a vesting schedule in place, even before investors arrive. We’ll also provide key, practical considerations for structuring a fair and effective founder vesting schedule that will assist with the long-term success of your startup.
WHAT IS VESTING?
Vesting is the process by which ownership of stock is earned over time. This means that an individual’s access to company shares is tied to their tenure with the company, with a percentage of shares becoming owned by the holder at regular intervals. For example, a four-year vesting schedule might provide that 25% of shares or options become vested after one year, with the remaining 75% vesting monthly over the next three years.
Founders usually purchase shares at incorporation for a nominal price or “par value.” Thus, for founders, “reverse-vesting” is used to give the company the right to repurchase a founder’s unvested shares should he or she leave before fully vesting.
WHY IS VESTING IMPORTANT?
Imagine if one of your startup’s founders left shortly after the business was formed, taking a significant chunk of ownership with them. This could be catastrophic for the remaining founders and the company as a whole in the eyes of investors. A vesting schedule ensures that individuals are committed to the company for the long-term and are incentivized to stay with the company, even during difficult times.
Investors know that a successful startup requires more than just a great product or service – it takes a strong team to drive growth and success. As such, investors need assurance that key executives won’t leave the company after their investment, or that these individuals are incentivized to remain with the company during its early stages. Vesting schedules provide investors with peace of mind by ensuring that founders are tied to the company for a specific period of time. So much so that investors will often insist on placing founders on a vesting schedule if they aren’t on one already – which can be a less advantageous vesting schedule than if the founders had placed themselves on one initially. By doing so, investors are better protected against the risk of a founder leaving early on in the startup’s journey, as it ensures that the company won’t be destabilized by a sudden departure.
Founder vesting schedules not only protect investors, but they also protect founders from uncommitted co-founders. By requiring a commitment of time to the company, vesting schedules ensure that founders are invested in the success of the company. Vesting incentivizes founders to stay with the company, rather than dropping out at the first sign of weariness or if another opportunity arises. If a founder were to leave the company before their shares fully vest, they would either forfeit their unvested shares or be forced to sell them back to the company at a predetermined price. Furthermore, the company might use those shares to further incentivize the remaining founders or to incentivize a new founder or hire.
Additionally, vesting provisions can increase the value of the company to potential acquirers. Acquirers often want to ensure that founders will remain with the company after acquisition, and vesting schedules can be a powerful incentive for founders to do so. This added value benefits all shareholders, including investors, key employees, directors, and advisors, who will see a financial benefit from an increased acquisition price.
Consequences of Not Being on a Vesting Schedule
If founders are not on a vesting schedule, they may be able to walk away with a significant portion of the company’s ownership, even if they leave early on. This can create instability and uncertainty for the remaining founders, investors, and the company’s other stakeholders.
Without a vesting schedule, there is also less incentive for founders to remain actively involved in the company. This can lead to a lack of commitment and drive, which can ultimately harm the business. Investors might also be reluctant to invest in the company with a material portion of the cap table allocated to the departed founder, who is no longer providing value to the company.
In addition, without a vesting schedule, it can be difficult to determine a fair allocation of ownership among the founding team. This can lead to disputes and resentment among team members, which can also negatively impact the company’s culture and performance.
How to Structure a Founder Vesting Schedule
So, how should you structure a founder vesting schedule? There is no one-size-fits-all answer to this question, as every startup and founding team is unique.
However, there are a few key considerations to keep in mind:
- Length of Vesting Period: Typically, founder vesting schedules run for four years. However, this can be adjusted based on the specific needs of the startup.
- Cliff Period: A “cliff period” is the initial period during which no founder shares vest. This is often set at one year, although it can vary depending on the circumstances. On completion of the cliff period, a material portion of the shares vest.
- Milestones: Vesting schedules can be structured based on time or to reward founders for hitting specific milestones, such as launching a product or reaching a certain revenue target.
- Accelerated Vesting: Accelerated vesting provisions can be included in the event of an acquisition or other significant event, allowing founders to earn their remaining ownership more quickly.
As a startup founder, vesting schedules may not be at the forefront of your mind. However, they are an important consideration for ensuring the long-term success and stability of your business. By structuring a fair and reasonable founder vesting schedule, you can protect the company from risk, incentivize founders to remain committed, and allocate ownership fairly among the team.
Don’t overlook this critical component of startup equity – talk to a competent lawyer familiar with the nuances of startups to ensure that your vesting schedule is properly structured and implemented.
