Vesting of Founder Shares in a Startup
When creating a startup, founders know that they have started down a long, winding road to what may or may not be success. Startups are created all the time, but not all of them last. This may be because it’s taking too long to turn a profit, reach public recognition, or simply grow beyond the margins of a startup into an actual business.
One issue that comes with this is the vesting, or bestowing, of founder shares in a startup. Most companies agree that, should one of the co-founders voluntarily leave the startup for whatever reason, it is in the best interest of the other founders, the investors, the company employees, and the company itself to ensure that the co-founder does not get to retain the entirety of their equity.
In fact, plenty of startups have jumped on board with a 3-5 year vesting period for founders’ shares. But is this the best approach?
Why it Might Be Better to Extend or Alter the Vesting Period
It’s no secret that businesses sometimes take a long, long time to take off. Some of the biggest businesses today such as Whole Foods, Apple, and Mattel began with next to nothing. Had it not been for their perseverance, they may have never become what they are today .
With this in mind, it makes total sense for the typical startup to take more than 5 years to really get rolling, and within this time, the startup may experience a number of ups, downs, and near deaths.
Due to this fact, some entrepreneurs agree that reconsidering the vesting period might be in the best interest for the business and its co-founders. In short, the period should be extended long enough to maintain the long-term incentive that a vesting apparatus delivers.
Ways to Approach Founder Vesting
It has become clear that most startups do not increase in value steadily over time, rather they have specific moments of productivity that give them a large boost. These moments, or events act as markers of a startups growth, and they are what most founders refer to when measuring the growth, value, and productivity of their company. These events are typically the following:
· Recruitment of Key Team Members
· A successful and clear Proof of Concept of core technology (PoC)
· The closing of a financial round
· The signing up of the first, real customer
Usually, the value of a business will be measured by these and like milestones , rather than linearly. Just because a company has been in existence for five years does not mean it’s doing well, however if a company has acquired key team members, customers, and financial stability, one could say it has definitely evolved.
Another way to approach founder vesting is to identify your own milestones. Your personal events may not look like the ones described above, which is why you can outline moments in your business that show you’ve arrived, or are close on your way. With this in mind, you can draw up just how much (or how little) a co-founder who voluntarily leaves gets depending upon when they leave and how the company is doing. For example, if a co-founder decides to exit before a round valuing of the company at, say, $1 million, most would agree they should get nothing. If however, they leave after this milestone but before the next, they should have about 10% of their total equity vested.
This way, the co-founder is clear about how much equity they’re walking away with, and the company hasn’t lost too much.
What Happens When a Co-Founder is Forced Out
When a co-founder is forced out of the company, things have to be handled a little differently. In this scenario, the ousted founder cannot be held responsible for value creation of the company and therefore, must be compensated with the mindset that that company value has already been created. The best way to do this is using accelerators that would become active in like scenarios and, therefore, accelerate the vesting level to one much higher.
In short, time-based vesting is not the best model to follow because there is no direct correlation between time put in and value of a company. Milestone or event-based vesting is the best as well as the simplest way to resolve the pitfalls that come with young companies, and help avoid the problems that arise when dealing with an old, time-based formula.
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