I’m a founder of a startup. Should my shares be subject to vesting?
Let's say you and your two co-founders have taken the plunge and decided to launch your startup and incorporate a new company. After several long conversations, the founding team has finally settled on how to divide the company's initial equity among the founder group. All that's left is to call your lawyers and tell them how many shares to issue, right?
Not so fast. In a company with more than one founder, issuing founder stock without subjecting those shares to vesting is never a good idea. Imagine that two months after issuing founder stock, one of your co-founders decides that the startup life is not for her and decides to return to her consulting career. If the founding group did not agree to subject their shares to vesting, the departing founder will leave the company with a significant portion of the company's equity, while the other two founders will be left behind to try and build the company themselves. Obviously this is not a great result for the two founders who have to shoulder the responsibility of keeping the company going.
Vesting Rewards Commitment
By subjecting their shares to vesting, founders agree to earn their shares over a specified vesting period. In order to continue vesting or earning his or her shares, a founder must continue to maintain a business relationship with the company (generally service as an employee, consultant or director will constitute a suitable business relationship for vesting purposes). If a founder ceases to maintain a business relationship with the company, then at the time the relationship ceases, the company will have the right to buy back all of the unvested shares held by the departing founder at the price that founder originally paid.
Subjecting founder shares to a vesting schedule helps align the interests of the founder group and insures that only those founders that remain committed to the company will benefit from the founder equity doled out at the time of the company's formation. It is important to note that investors will also expect that the shares granted to the founders will be subject to vesting given the important purposes served by requiring founders to earn their founder shares.
Create Your Vesting Plan
The of the founder group should agree on vesting parameters applicable to all founder shares. The key decisions to make include determining the duration of the vesting period (typically a four-year vesting period, with no shares vested until the end of the first year of continuous service to the company—a so-called one-year cliff period because no shares vest until the founder reaches the end of the cliff period—and equal monthly vesting installments thereafter until the fourth anniversary of the date the shares were granted to the founder) and whether or not any special vesting acceleration provisions will apply (for example, upon a sale of the company or certain other specified events, such as termination without cause).
Subjecting founder shares to vesting also may have important tax implications. A founder who receives shares with vesting provisions may benefit from the filing of an 83(b) election with the IRS. 83(b) elections must be filed with 30 days of the date that the shares first became subject to vesting restrictions.
Applying vesting provisions to founder shares in a company with more than one founder almost always makes sense. You should discuss the ins and out of vesting with your lawyer at the time of the company's formation.