Making sure co-founders have a vested interest
Tuesday, July 28, 2015/
Are you about to form a new startup with a co-founder and wondering how you can make sure that both founders remain committed in the formative years? Are you wondering how you can ensure if one founder quits early that he or she isn’t able to ride on the coat-tails of the remaining founder simply because they retain their shares in the company?
A potential solution to these issues is founder vesting. In essence it means:
- If a founder quits or is forced to leave before the founder’s shares have vested, then the company has the right to buy those shares back, for say, as low as $1.
- A founder cannot sell their unvested shares;
- As shares vest they are no longer at risk of being bought back by the startup and can be sold by the founder, even if they quit or are forced to leave.
It works a bit like this:
- At the outset all founders agree to a vesting schedule. The vesting schedule is usually set over a four-year period.
- If a founder quits or is forced to leave within the first year the founder forgoes all of their shares. This is often called the “one year cliff” and is generally considered commercially fair for startups because if you are going to make a meaningful contribution to the company, founders should be there at least one year.
- From then on 1/36 of a founder’s shares will vest every month (i.e. the rest of the three year vesting schedule broken down into monthly increments). So after two years, 50% of a founder’s share will have vested, 75% after three years and all of the shares will have vested after four years.
There are circumstances where it is necessary for all founder shares to vest early and immediately, such as on a sale or IPO of the company.
Apart from co-founders wanting to “keep each other honest” during the formative years of the startup, having a reasonable vesting schedule in place gives a positive impression of the founders’ commitment to potential angel investors or venture capital funds.
What’s more, if you already have a reasonable vesting schedule in place investors are less likely to insist on a more onerous regime before they will invest (well, that’s what the nice investors say).
The most effective way to have a founder vesting schedule for your startup is to incorporate it into the company’s shareholders agreement. Another good reason for having a shareholders agreement from the outset.
Brad Vinning is partner, corporate and commercial at ClarkeKann Laywers.