Founder Vesting refers to the process through which founders retain their ownership in the form of stock options, remaining fully vested over a period. This process ensures they are committed to their ventures and work toward enhancing the firm's efficiency and productivity levels.
It is required to preserve the interests of all parties involved, including investors, co-founders, and the company. It incentivizes founders to stay with the company for a prolonged period and links their ownership stake with their continued contributions. Furthermore, the procedure helps to limit the risks associated with founders departing the company early or failing to fulfill their commitments.
Founder vesting is the act of applying a vesting period for founder stocks. This gives them gradual ownership, where shares are received proportionally over a period. Entrepreneurs often question why their stock should be subject to vesting, mainly when they're focused on growing their company. However, it is crucial to recognize that most startups involve multiple founders, any of whom may depart unexpectedly.
Without vesting, a departing founder could retain all their stock, leaving others to shoulder the work and risk. In other words, when founders are issued shares, the company may have the option to repurchase these shares if a founder departs prematurely. However, vesting the founder's share repurchase right gradually expires over time. Vesting ensures that founders earn the right to retain their shares gradually. Typically, a standard founder vesting schedule involves a one-year cliff, and the remainder normally vest monthly over a set term of three or four years.
Stock received at the company's inception compensates founders for immediate and future contributions, ensuring equitable distribution and commitment to long-term success, implementing vesting safeguards against disproportionate benefits, and fostering accountability among founders.
When founders decide on the timing and conditions for vesting a founder's stock, they assess factors like intellectual property contributions, pre-formation time investment, payment (short-term or otherwise), and commitment levels. While a standard vesting plan usually grants 25% of stock upon formation, with the remainder vesting over a set period, founders may adjust this based on individual circumstances. Factors such as prior contributions, level of commitment, and financial arrangements may justify modifications to the vesting schedule to ensure equity and reflect each founder's role and dedication to the company's growth.
A founder vesting agreement typically contains the following details:
Founder vesting agreements vary between companies, but they generally serve to align incentives, protect shareholders' interests, streamline funding negotiations, and promote long-term retention of key team members. Please refer to this founder vesting agreement template to understand it more clearly.
Let us look into a few examples to understand the concept better.
Daisy is offered 200 shares in the company with a 4-year founder vesting schedule period and a one-year cliff. This implies that Daisy will receive the first 50 shares only at the end of the one-year cliff period. After that, the remaining 150 shares will vest monthly on an incremental basis for the next three years (50 shares per year). If Daisy leaves before completing the cliff period, she forfeits rights over all 200 shares. If she exits by the end of the second year, she will leave with 100 shares, and so forth.
Here's a breakdown of Daisy's shares over the four years:
Snapchat, now known as Snap Inc., implemented a founder vesting period with a four-year vesting schedule and a one-year cliff period. New hires are granted stock options that vest gradually over four years, with a portion typically vesting after the one-year cliff period and the remainder vesting monthly after that. This structure incentivizes employee loyalty and commitment to the company while also mitigating risks associated with early departures. Additionally, the treatment of unvested shares upon termination is typically outlined in the vesting agreement.
There are many reasons why this arrangement is essential, and they are given as follows:
A vesting plan encourages founding team members to continue promoting the company by ensuring ongoing shareholder participation. Shareholders become owners only after vesting is completed, and those who leave before the schedule expires must forfeit unvested shares. This contributes to the company's success.
A vesting schedule precludes early team members from being a free rider and ensures that co-founders receive shares equal to their contributions. It eliminates the possibility of an outsider dominating the company's management processes and future earnings when a person with entire ownership leaves. A suitable vesting schedule ensures that co-founders earn shares in proportion to their contributions at any given moment.
Introducing vesting for the founder's shares at the company's inception also serves to streamline subsequent negotiations with investors for funding. Investors anticipate founders will retain a substantial share of stock, still subject to vesting, to ensure their ongoing commitment to the company. The absence of unvested stock can signal a significant issue to investors, leading to more intricate negotiations. Founders are advised to establish a reasonable vesting schedule early on to preempt potential conflicts during future discussions with investors. This promotes alignment of interests and facilitates smoother investment procedures.
The vesting schedule enables businesses to keep employees or shareholders for extended periods, allowing them to use their stock options only when they have fully vested. This keeps them from losing their founder's equity if they look for better opportunities before the vesting period concludes.
The establishment of founder vesting usually involves founders creating and finalizing a vesting agreement that details the duration of vesting, the presence of a cliff period, and the frequency at which equity is vested. Seeking legal advice is recommended to ensure adherence to relevant laws and regulations.
How long is the founder vesting?Founder vesting typically spans over several years, commonly ranging from three to four years. This duration is specified in the founder vesting agreement, which outlines the gradual transfer of ownership rights to founders. Within this timeframe, founders earn their equity stake by actively contributing to the company's growth and success.
What is a cliff period in founder vesting?A cliff period in founder vesting refers to an initial period within the vesting schedule during which no ownership of shares is granted. It serves as a milestone that founders must reach before they begin to vest their shares gradually according to the agreed-upon schedule. Typically, once the cliff period expires, founders start earning ownership rights to their shares based on their continued involvement and contributions to the company.
This has been a guide to what is Founder Vesting. Here, we explain the concept along with its agreement template, examples, and importance. You may also find some useful articles here -
