Why Your Startup's Founders Stock Should Vest Over Time
If your startup company launches with more than one founder and your startup plans to eventually be acquired or seek venture funding, your startup’s founders stock should vest over time according to a vesting schedule.
Founding teams might not stay together. And having a missing founder or two with a nice chunk of your startup’s common stock is not a scenario your startup wants when it comes time for an acquisition or venture capital financing.
So instead of the founders getting all their shares of common stock on Day 1, the founders get their stock according to a vesting schedule. The standard vesting schedule for startup companies is four years with a one year cliff and monthly vesting thereafter until the founders reach 100%. The one year cliff means that the founders do not get vested with regards to any common stock until the startup’s first anniversary. Thereafter, the founders get vested every month at an amount equal to 1/48th of the their total common stock.
If a founder leaves before the startup’s first anniversary, the founder leaves without any common stock. If a founder leaves after 15 months, the founder will have 31.25% of his common stock vested (25% after the first year, plus the 2.083% vesting each month for 3 months). Thus, the missing founder leaves the startup with much less shares than if the founders stock had vested immediately. This makes it easier to get the necessary approval (and other issues) to go forward with an acquisition or venture capital financing.
About the Author
Ryan Roberts is a startup lawyer and represents technology companies through all phases of the startup process, including incorporation, seed & venture financings, and exit transactions. Click here to learn more about his practice.
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Great article and a very important principle to keep in mind. Quick question, what if both startup founders have been working for a year before actually incorporating? Would you recommend changing the 1-year cliff or maintaining the same schedule? Also would the vesting schedule change at all if some one joins for pure sweat equity? A 1-year cliff may seem unfair for someone who isn't getting compensated at all.
You could either skip the cliff or reduce the term from say 4 to 3 years (and still keep the cliff). I'd probably recommend keeping the one year cliff to keep the founders "hungry."
As for the sweat equity/cliff issue, there's a few considerations. As you mentioned, this person's only compensation is the equity. But if he or she is not receiving cash compensation, presumably this person is working somewhere else for cash compensation and thus NOT fully involved with your startup. Therefore, he or she would be vesting the entire first year while working somewhere else.
Thanks for the very informative blog! As a startup trying to undestand how to set up a business and finding it somewhat frustrating understanding all of the variables, especially on the financial side, you are good at explaining the details in layman's terms.
Hi Ryan,
Great post, thanks for all this valuable info. I'm starting a company and have a few questions of clarification.
1. I am the original founder (my business idea) and am bringing on a partner/co-founder to help me start this business. Should the vesting schedule apply to both myself and my co-founder, or just to my co-founder?
2. Should I incorporate and issue all shares to myself initially, and then give shares to my co-founder (vested or otherwise), or just set it up according to the equity split right off the bat. (but then the vesting becomes moot I would guess??)
3. When you refer to stock vesting, this is a separate pool than the options that will be given to employees, correct?
Thanks,
Richard
1. Really up to you. Think about team cohesiveness, also. Any VC will want to see the whole team with the vesting schedule.
2. Issue to those who will be part of the team.
3. No, in this article I was just talking about founders' common stock vesting over a period of time. Not options to employees.
Your post is very informative. I have a question similar to Richard's. Can I issue shares to myself only when I incorporate, and later issue founder's stocks with par values of 0.1 to 0.00001 to my co-founders?
Thanks,
Jo
You can issue stock at different times, but I don't suggest doing so if everyone is "on board" at the same time. But if it's just you at the beginning, then yes, issue stock to yourself and then to your co-founders as they come on board. As for par value, it should be the same for the common stock. The issue price may be different, however.
How does 409A apply to the deferred compensation from the 4 yr vesting + clff? Does timing of the issuance factor in, or is a valuation always recommended?
What if the founders worked beforehand as a common law partnership, contributing these partnership interests (and resulting IP) to the newly formed entity?
Great post. What happens when the team is a bunch of students? I had a business idea late 2008 and came to campus in 2009 looking to build a team to build the business. 4 months and a working prototype later two of us are doing it full time, while the other three will be doing it part time. The other three are brilliant, so I really want them to be on board, but there is the risk that they aren't able to contribute because of school.
Therefore, I guess I have two questions:
1. I promised 3 of the initial team members stock (totaling less than 20%) to get this business running. They have definitely earned this. Is there anything I should/ can do to keep them involved/ protect the company before handing this over?
2. How should stock be issued from here in for the 3 part time contributors? Have one vesting schedule for part time involvement, with the option to switch to a different vesting schedule if they come on full time?
Thanks,
Ted
Ted,
1. Vesting schedule should do that.
2. Up to you, but it's probably easier just to grant them more stock or options if they come on FT.
Dear Ryan,
I started a business in march of 2007 with a Friend of mine while PhD students – we have it incorporated as an LLC. As we were both scientists, we brought in a MBA student as our CEO, with the same timeline that we had to finish. Now that we are finishing our PhD, but I tried to negotiate staying here because of the company, but as my scholarship was from my home-country, they didn't accepted my offer and I'll be forced to come back now after the completion of my PhD. During this 2 years we had secured a state grant, and have a posdoc working in our prototype with great progress. We had also developed other patents (3-4) in addition to the one we filed and licensed from our university, which will be filed as soon as we secure VC investment – we are in due diligence right now.
As I will have to leave, we are looking for reasonable figures for the equity split that would not hurt the company. I'll continue as a scientific advisor. Our timeline for commercialization and a possible acquisition/exit is in 18-30 months from now.
Me and the other PhD started with half of the shares, and the MBA is vesting 10% over 5 years.
Sorry for the huge question, with a lot of variables but any insight or reference where I could look for would be really appreciated.
Thanks.
Great article Ryan.
Question: Am I correct in the following assumption?
1. If the founders are all on a vesting schedule then their whole share allotment (vested and non vested) is subject to dillution as new investors come on board?
Thanks!
Joseph – yes, the whole share allotment is subject to dilution.
Thanks Ryan – very informative!
I started a C corp based on my IP (licensed from U); my main guy comes in as a CTO; no salaries, part-time jobs; all the money – from my personal account. I am structuring it as founders common stock (granted) and common stock (purchased). Another faculty wants to come in (no experience, contacts, future participation in activity) – should he be granted founders common? Or allowed to purchase common? At this stage – w/o company docs, by-laws, etc – he is taking a greater risk than future investors; should he be granted founders shares and standing? I realize there are no obvious rules, but what's the practice? Is he a founder or an early investor?
Thanks much!
Great stuff – 1 question: If a founder has vesting according to the recommended schedule. And let's say it get's aquired at year 2 or so. What are the possible scenarios after that? Is it up to the buyer to decide upon accelerated vesting or what are the likely scenarios?
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How does vesting apply to an LLC? My partner and I would like to put a 4 year vest on our ownership units. Do LLC owners generally issue all the units and just have a buy back agreement related to time with the company if a founder leaves early?