If you are capital raising as a founder of a startup, potential investors will mention vesting requirements for you and other founders.
We have explained below what founder vesting is, and what you might need to negotiate.
What is vesting?
Founder vesting is the concept that a founder’s ownership of the company is earned over time, like a salary.
Technically speaking, this is ‘reverse’ vesting – a founder has shares at the beginning, but if the founder leaves the company, decreasing proportion of the shares held by the founder (related to the time the founder has been with the company) have to be sold back to the company, usually at no profit.
Why do investors want vesting?
Founder vesting helps to avoid a founder leaving early on in the life of a startup with a large equity stake. This is really important as that may make the startup uninvestable in the future. Vesting is intended protect both investors and the company.
What does vesting look like?
Typically if a founder leaves the company before the end of the first year, all the shares will have to be sold back to the company at no profit. This is known as the ‘cliff period’.
After the cliff period, a percentage of the shares will vest each month to the founder until all the shares have vested. The founder will own the vested shares outright without the requirement for the shares to have to be sold back to the company at no profit. You should note, however, that there are likely to restrictions on transfer of the shares in the articles of association and the investment agreement.
The table below set out an example vesting schedule over a 4-year period:
Period of time Shares vested
Up to 1 year 0%
At year 1 25%
At year 2 50%
At year 3 75%
At year 4 100%
What do I need to think about with founder vesting?
As a founder, you should consider the following issues, and whether they will be the same for each founder:
Vesting commencement date: This is usually the date of incorporation of the startup. An earlier date may be appropriate for a particular founder who has worked on the business before then or invested significantly more resource or time in developing the startup than the others.
Length of the vesting schedule: If your startup has a short vesting schedule, investors are likely to want to increase it before investment.
Cliff or straight line vesting: You will want to think about whether the shares should vest only after a period of time has elapsed (cliff) or immediately (straight line).
Vesting frequency: Shares typically vest each month, but vesting could be quarterly or annually.
Do you need advice about your capital raise?