Founder Fridays: Protecting Your Ownership Interest in Founder Shares
We’ve decided to bookend Fred Wilson’s MBA Mondays with Founder Fridays, a series of posts dedicated to legal concepts relevant to founders explained in simple terms. The first Founder Fridays post is about vesting on founder shares.
As with other equity incentives, the shares of stock that a founder receives are often subject to vesting. Vesting restrictions require the founder to remain in the employ of the company in order to “earn” his or her shares. Investors will invariably require vesting on founder shares as a condition to their investment, and many companies implement vesting on founder shares in advance of seeking funding. Typically, founder shares, as with other employee equity incentives, vest over a four- or five-year period. While most employee grants include “cliff” vesting (e.g., 25% of the shares subject to the award cliff vest on the one-year anniversary of service, with the remaining shares vesting in equal or quarterly monthly installments over the following three- or four-year period), vesting on founder shares often does not. Some founders are successful in negotiating to have a portion of their shares vested up-front for prior services or value contributed to the company.
Whether a founder’s shares are subject to acceleration in certain circumstances can be hotly negotiated. For example, a founder may argue that he or she should not be required to forfeit all or some portion of his or her unvested shares if he or she is terminated without cause or leaves the company as a result of being forced into a lesser role or having compensation materially reduced. A founder may also argue that his or her shares should be subject to full acceleration on a sale of the company under the theory that the founder should not forfeit his or her shares in the event the company is sold prior to completion of the vesting schedule.
Founders and investors should be thoughtful in implementing these features. Consideration should be given to the likely role of the founder post-acquisition. For example, will the acquirer likely expect the Founder to remain in the employ of the company or the acquirer following the closing? If so, full acceleration may not be appropriate, as the acquirer may find it necessary to implement other retention incentives for the founder on a post-closing basis, which typically would be structured to be deducted from the consideration otherwise paid for the company in the transaction. A typical compromise is the implementation of “double trigger” vesting, which often provides that the founder’s shares are fully vested if he or she is terminated without cause (and often if demoted or the subject of a salary reduction) within some period of time (often six or 12 months) following a company sale. A double trigger structure incents the founder to stay with the company/acquirer through some post-closing transition period, but also protects the founder from having his or her shares forfeited in the event that the acquirer does not value him or her as a continuing part of the business going forward. There are different variations of double trigger vesting with some providing for acceleration up front (e.g., 50%) of the unvested shares.
Vesting and acceleration provisions, part of the Founder Stock Restriction Agreement, need to be carefully thought out; otherwise unintended consequences can result. This agreement, as well as all other documents necessary for company formation, can be created on the Founders Workbench Document Driver.
This post on Equity and Start-up Issues was authored by Nithya Das.