Startup Lawyer | Why Your Startup’s Founders Stock Should Vest Over Time
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Why Your Startup’s Founders Stock Should Vest Over Time

Posted 11 Jul 2008

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…not to mention allow you to spend that repurchased equity to new hires/founders.

48 Comments
  • Ben
    Posted at 11:45h, 06 February Reply

    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.

  • Ben
    Posted at 06:45h, 06 February Reply

    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.

  • Ryan Roberts
    Posted at 13:55h, 06 February Reply

    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.

  • Ryan Roberts
    Posted at 08:55h, 06 February Reply

    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.

  • Jim
    Posted at 13:41h, 11 March Reply

    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.

  • Jim
    Posted at 08:41h, 11 March Reply

    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.

  • Richard
    Posted at 22:49h, 24 March Reply

    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

  • Richard
    Posted at 17:49h, 24 March Reply

    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

  • Ryan Roberts
    Posted at 16:26h, 29 March Reply

    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.

  • Ryan Roberts
    Posted at 11:26h, 29 March Reply

    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.

  • Jo
    Posted at 16:24h, 09 April Reply

    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

  • Jo
    Posted at 11:24h, 09 April Reply

    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

  • Ryan Roberts
    Posted at 08:38h, 14 April Reply

    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.

    • Mike
      Posted at 14:35h, 26 May Reply

      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?

  • Ryan Roberts
    Posted at 03:38h, 14 April Reply

    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.

    • Mike
      Posted at 09:35h, 26 May Reply

      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?

  • Ted
    Posted at 23:26h, 14 April Reply

    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
    Posted at 18:26h, 14 April Reply

    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

  • Ryan Roberts
    Posted at 10:44h, 16 April Reply

    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.

  • Ryan Roberts
    Posted at 05:44h, 16 April Reply

    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.

  • Laura Terious
    Posted at 15:07h, 02 June Reply

    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.

  • Laura Terious
    Posted at 10:07h, 02 June Reply

    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.

  • Joseph Shavit
    Posted at 12:16h, 09 December Reply

    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 Shavit
    Posted at 07:16h, 09 December Reply

    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!

  • Ryan Roberts
    Posted at 16:31h, 06 January Reply

    Joseph – yes, the whole share allotment is subject to dilution.

  • Ryan Roberts
    Posted at 11:31h, 06 January Reply

    Joseph – yes, the whole share allotment is subject to dilution.

  • Victor Levenson
    Posted at 09:35h, 17 February Reply

    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!

  • Victor Levenson
    Posted at 04:35h, 17 February Reply

    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!

  • Jakob
    Posted at 01:50h, 18 March Reply

    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?

  • Jakob
    Posted at 20:50h, 17 March Reply

    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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  • Robert
    Posted at 10:31h, 05 June Reply

    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?

  • Robert
    Posted at 05:31h, 05 June Reply

    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?

  • Verne
    Posted at 23:12h, 14 October Reply

    Thanks for the valuable insight. I am contemplating working for a company that started 3 years ago. They are a private entity. Part of my compensation will be in the form of employee stock options. I wanted to understand what percentage of ownership I would have with my shares. When I asked them how many total shares outstanding there were; they said they could not tell me that becaused as a private company, this is priviledged information. It sounds shady to me, should I be concerned?

  • Verne
    Posted at 23:12h, 14 October Reply

    Thanks for the valuable insight. I am contemplating working for a company that started 3 years ago. They are a private entity. Part of my compensation will be in the form of employee stock options. I wanted to understand what percentage of ownership I would have with my shares. When I asked them how many total shares outstanding there were; they said they could not tell me that becaused as a private company, this is priviledged information. It sounds shady to me, should I be concerned?

  • Anonymous
    Posted at 06:11h, 11 December Reply

    Hi Ryan,

    Thanks for all the great content. Quick question: who controls the founder’s shares while they’re being vested? Is there an escrow for that or does the attorney handle this?

  • Victor
    Posted at 14:34h, 07 February Reply

    Ryan,

    With cliff vesting, what is the usual and customary method for creating the founder stock certificates.

    Thanks

  • Kevin
    Posted at 10:30h, 17 February Reply

    Enjoyed reading the information. Have a question about startup documents. I have a company and, unfortunately, have already signed documents with some for percentages of the company. That being said, the founder’s stock purchase agreement was to be presented to them this week. Can I still give them a vesting schedule along with the stock agreement, or am I stuck?

    Looking forward to your response…thanks.

  • Michael
    Posted at 23:39h, 14 March Reply

    Maybe I’m missing the obvious…

    1. How is percentage of profit determined when all stock has not yet been vested? If a company turns a good profit in year 3, but stock has not yet fully vested, how is profit distributed?

    2. If the company is acquired, is all stock distributed and paid out?

    3. If a company has undergone funding, and a founder drops out, what happens to his/her stock? Does it get split between the founders at their ownership level to later vest to them? Do the investors now receive a portion of it relative to their stake?

  • Michael
    Posted at 19:17h, 15 March Reply

    And definitely, thank you for the helpful post. These topics overwhelm my small brain.

    • Joseph
      Posted at 18:06h, 14 June Reply

      Hi Ryan:

      I have a startup company, established last year with 20MM shares authorized and I have issued 3MM shares already. I like to raise $1MM for my project, I have few questions hopefully that you could shed some light to my confusion:

      1) If I raise $1MM at $1.00 each. Hence I’m giving up about 25% of the company already. Is this a bad idea to start with, since I should own more shares from the beginning, let say 50-60% of authorized shares. If that is the case, what could I do to remedy the issue. Could I do the vesting schedule for more shares?

      2) Which offering would be best Reg. A and SCOR or Reg. 504. I want to advertise publicly, since it’s easier to raise fund. Why not too many people using Reg. A as my understanding.

  • Clark
    Posted at 11:43h, 26 July Reply

    what if your company is bought out before your first anniversary? I know this isn’t statistically common but I’m sure it happens.

  • Nate
    Posted at 13:51h, 17 August Reply

    Hi Ryan

    Great post. I have a few questions regarding my venture. Sorry about the lengthy response.

    I’m in the process of forming an LLC for a venture that I started. I brought-in a co-founder (personal friend) who serves as my technical arm. We have a customer and need to form the company asap.

    Questions:

    1. Should I form the LLC with a 100% stake first and then sign a MoU with the co-founder awarding him a stake with a vesting schedule? Or, should I include him as the member of the LLC at the time of formation? Are there pros/cons for either approach?

    2. If I was to apply a vesting schedule for a stake, how does it work when the LLC is being formed? I’m planning to use legal zoom or Nolo to save on costs. Does LegalZoom or Nolo allow for setting-up memberships with a vesting schedule?

    3. If one was to form the LLC with 100% stake, is it of any advantage to have your spouse be a stakeholder too irrespective of whether he/she is a contributing member of the company? For example, I start the LLC with the following:

    T=0:
    member 1 (co-founder 1): 89%
    member 2 (co-founder 1′s spouse): 11%

    T1=T+1 month:
    member 1 (co-founder 1): 51%
    member 2 (co-founder 1′s spouse who is not contributing): 8%
    member 3 (co-founder 2): 41%

    Assume at T2 we receive interest from a VC, and assuming we change the company from an LLC to a C-Corp., and the company is valued at $100K.

    T2=T+1 year
    member 1 (co-founder 1): 51% – value $51K
    member 2 (co-founder 1′s spouse who is not contributing): 8% – value $8K
    member 3 (co-founder 2): 41% – value $41K

    Will the value of member2′s stake (per share) be perceived any lesser than the other members because of the fact that the member was not an active contributor within the company?

    Usually, the VCs put a multiplication factor to buy-out the shares from the respective shareholders. Assuming the factor is 3x (average for a product company), will member2′s factor be any lesser because he/she is a passive stakeholder?

    Any input is appreciated.

    Thanks
    Nate

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  • Peter
    Posted at 10:28h, 19 January Reply

    Dear all, besides the vesting, management has usually a lock-in period in case of a successful exit before they can take on new ventures. How long is this period usually and do you have examples? Many thanks!

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