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Startups rarely (if ever) go perfectly to plan; things often go wrong and life throws up all sorts of scenarios that can have an impact. Sometimes things get so bad that founding teams split up. The chances of this are often increased where you have large founding teams formed in a short period of time (i.e. when the team haven’t really worked together before). Regardless of the size of your team and the likelihood of a founder fallout, how big an impact such a split has on your startup can make or break it. This is where vesting comes in.
One of the primary drivers behind the idea of vesting is to help reduce the impact of a co-founder leaving by ensuring they don’t leave with a disproportionate amount of equity. How this often works is that founder shares vest over time. So, as a founder you are 100% vested when you “own” 100% of the shares that have been allocated to you. For example (very simplified):
if you have a straight-line (meaning you vest daily a proportion of shares) vesting schedule in place over 4 years and you started vesting 2 years ago you will have vested 50% of the shares allocated to you.
Vesting is important to ensure that, should a co-founder leave during the vesting period, there is enough equity left in the company to adequately incentivise the remaining founders and team. This is even more important when you think that the company will likely have to hire someone to replace the departing co-founder and they will likely want a chunk of equity. Often vesting is thought of as solely an investor protection provision requested at the time of a fundraising round. I always advise founders not to think of it purely this way because, as described above, it helps protect against a potentially catastrophic impact of a founder fallout situation for all stakeholders (founders and investors).
Personally, I’m always impressed with founders who think about vesting early on and appreciate the theory behind it. Often vesting schedules are set over 3–4 years with some form of a cliff after one year. This means that an amount (often 25%) is deemed to be vested only after one year of continued work (the “cliff”), with the remainder vesting incrementally on a straight line basis over the following 2–3 years. For example (assuming 4 years):
All sophisticated investors will request some form of vesting schedule should you raise a round of financing from them so it’s worth giving some thought to this when you’re starting out.
I haven’t really dived into the nitty gritty of specific terms in this post (in particular I haven’t looked at the circumstances around founders leaving (i.e. Good Leaver, Bad Leaver, Acceleration on Exit etc.)). It goes without saying how important it is to fully understand any legal documents and the implication of the terms contained therein.
The above points are by no means exhaustive and I’d love to hear feedback or potential additions, you can find me on twitter @tom_wils.
We’ve made it free for new startups to create their vesting agreements on SeedLegals 7-day trial. No credit card required.