What is Founder Vesting?
Background
You and your two co-founders start a business. You split up the ownership of that business among the three of you. 10 months later, one of your co-founders leaves the business. Maybe they get a job offer that they can’t refuse, or they have a falling out with you and your other co-founder.
It wouldn’t be fair if they got to keep the ownership interest they were initially given as a founder, would it?
The ownership interest was given to them on the assumption that they’d be contributing in significant ways for the foreseeable future. It was there as an incentive for all the blood, sweat and tears they would be putting into their business. But now, things have changed.
How do we ensure that the ownership of the business gets fairly readjusted among the founders to reflect this new reality?
That’s where “Founder Vesting” becomes helpful.
How it works
Each founder receives all of their shares on Day 1. But! If a founder leaves the business or stops providing services to the business, the Company has the right to take back the founders shares. This is called a “repurchase right”. The number of shares that the Company can repurchase from the founder decreases over time. The longer the founder stays with the Company, the less shares the Company can take back if they leave (or put another way, the more shares the founder gets to keep if they leave).
Under the repurchase right, the Company may repurchase unvested shares at the same price they were issued to the founder (which is typically a nominal price ~ $0).
This repurchase right is critical, because without it, the leaving founder would have no obligation to give up any of their shares.
The standard vesting schedule
The standard vesting schedule is 4 years, with a 1 year “cliff”.
Under this vesting schedule, all of the founder’s shares are subject to that repurchase right.
None of the shares are released from that repurchase right during the first year. On the first anniversary date, 25% of the founder’s shares vest (or, are released from the “repurchase right”). This is called the “cliff”. After that, founder shares vest (or, are released from the “repurchase right”) in equal increments each month for 36 months.
While that is the “standard” vesting schedule for a high-growth / technology company, vesting schedules can be customized. The timeline can be changed (shorter / longer / more frequent vesting / less frequent vesting), the structure can be changed from time based to milestone based (ex: 25% vests upon reaching $50k monthly recurring revenue), or a combination of the two.
Ink LLP is a business law firm that acts as strategic counsel to ambitious entrepreneurs, investors, and high-growth companies. Contact one of our lawyers to discuss your business and how our team might be able to help you tackle the challenges of your business and the opportunities for growth.
This information is provided for informational purposes only and is not legal advice.