By Fernando Berrocal
Many new entrepreneurs are astonished that they must have a vesting schedule for founder ownership. In this case, it's true even when they are a solo founder (a business creator that is establishing a startup without any form of partnership.)
All types of investors anticipate a vesting schedule. If you don't have one when you raise a priced round, you'll be obliged to add vesting to your founder shares as part of the round's conditions. This happens since the different types of investors need to know that you're serious about your business. They must also be certain that they won’t walk away with a significant ownership position before the project is complete. When the board of directors of a growth-stage firm authorizes additional stock awards to the founders, they are usually connected to a new vesting schedule (or growth objectives.)
In terms of vesting schedules, the industry standard is for founders (and all startup workers) to have a 48-month vesting period with a one year cliff. This implies that one quarter of your shares will vest on your 12-month milestone with the firm. Following that, each month, another 1/48th of your shares will eventually vest, until your shares are completely vested after 48 months.
A longer vesting term for the founders is acceptable to investors and even preferable for aligning incentives among the founding team. Otherwise, a shorter time may raise suspicions and will almost certainly be renegotiated at a subsequent fundraising round.
What occurs if you leave the business with unvested stock? Since you don´t own these shares, the firm can seize them. The business can exercise a buyback option for unvested shares with common and restricted share awards that have a vesting schedule. Then, you (as the shareholder) pre-authorize the repurchase of any unvested shares when registering for the initial grant. The buyback right is usually available for ninety days after you leave.
Investors dislike seeing dead equity on the cap table. They don't want stockholders with big ownership holdings on the cap table if they aren't actively participating in the firm's development of the business or product growth. If you or a co-founder leaves the business with 30% ownership, the incentives are mismatched for the organization's future growth. This is why investors want founders on a vesting schedule, to avoid these kinds of situations. Also, take notice that founder vesting should concern more than just the business investors. If you have started your enterprise with co-founders, you'll want to place each of them on a vesting schedule so you don't end up with dead stock on your cap table if there's a disagreement.
Is there a need for a vesting schedule for equity if you have previously worked on a startup before incorporating? Yes, as a matter of corporate legal hygiene - and to signal to investors that you are for the long haul - you’ll want to have a vesting timetable in place in these instances. If you have co-founders, this is especially critical–this way, if someone opts to depart, the firm may continue to operate without any dead equity on the balance sheet.
Since you worked on the business before incorporation, it may be reasonable to make one change to the vesting schedule for your founder shares. You may allocate a percentage of your shares to vesting (such as 20%.) Even this minor alteration may cause investors to raise suspicions during due diligence. Most of the work that founders perform when it’s a side project is discounted by investors, especially if the founding team is not working full-time.
What happens to a vesting schedule when a startup raises a Series A? When you raise your Series A financing round, a few things will change with your cap table.=:
- The size of your Employee Stock Option Pool (SOP) is negotiated. Generally, investors may request that the option pool be expanded so that enough shares are set aside to encourage important employees as the firm grows. Since this is another source of dilution for the founders' ownership interest, founders and investors usually argue over the size of the option pool before signing the investment term sheet.
- You may be requested to adjust your vesting schedule depending on how many shares you will have vested by the time of the financing.
Founders should have vested a maximum of 40% of their initial share award by the time of Series A, according to VC lawyers. Investors may seek to change the conditions of your vesting schedule as part of the financing if you have vested more. Keep in mind that if you're in the middle of Series A discussions and your whole founder stock reward has already vested, you'll almost certainly be requested to add a vesting timetable.
You want as little friction in the finance negotiations. It's typically easier for a founder to set up their cap table in the way that investors expect from the start. Many entrepreneurs are unaware that as part of their equity funding rounds, they are responsible for their investors' legal expenses. Every time a startup tries anything unusual, they end up paying three times in legal expenses.
How is this possible? The startup pays its attorneys upfront to write non-standard contracts. The business then hires the attorneys of its investors to spot the non-standard agreements during due diligence. Finally, to avoid the funding transaction, the business will hire its attorneys to modify the non-standard documents.
When you sell your business, what happens to unvested shares? The procedure is simple when a business sells early to an acquirer and the founders have unvested shares. The founders are generally board members, and they can sign off on accelerating their shares vesting before the acquiring business completes the acquisition of the organization's stock. A prevalent fallacy among founders is that when their firm is sold, only the shares that have already vested would be considered to calculate the distribution to the founders and shareholders.
Founder equity awards aren't usually done as options; instead, founders buy common stock when they start their business, and the vesting schedule, in this case, is that the shareholders pre-authorize the buyback of any unvested shares if they depart before they're completely vested. In the case of an early acquisition, the organization's board of directors simply decides not to repurchase the unvested shares from the founders before the acquisition.
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