Why Founders Should Vest

24th October, 2012 No Comments Blog , Venture Capital

My experience has been that most founders have not thought about vesting their own shares before raising outside capital for the first time.  I think they should, in most cases, vest their shares of their own accord, even before talking to an outside investor.

Vesting, for those unfamiliar with the term, refers to earning equity (options or shares) over time.  A four-year vesting schedule with a one-year “cliff” is a pretty typical arrangement.  Under this schedule, an employee’s shares vest over four years, with 25% becoming the employee’s outright after one year and the balance vesting monthly over the subsequent three years.  A buyback provision, which enables the company to buy back a portion of an employee’s shares, can accomplish the same thing; consult your attorney about this option.

Vesting is important because it aligns employee incentives (ownership) with the goals of the company (continuity in the employee base).  Also, for an employee with many shares departing before vesting is complete, some of his shares will be returned to the company; those returned shares can then help the company to entice a replacement to take the position.

This rationale is especially applicable to founders, who are typically allocated large equity stakes (and for good reason).  Not only do founders have many shares, but their premature departure can spell big trouble for a company, and replacing one of them often requires a significant equity compensation package for a new hire.

In spite of this logic, founders do not put in place a vesting plan for their own shares.  The rationale they often use is that the company is theirs, so they should not have to “earn” their equity.

I believe it nearly always makes sense to institute a vesting plan for the founders.  Even without an outside investor who is concerned about the issues outlined above, each founder should expect the other members of the founding team to commit to the company.  A vesting plan underscores that commitment and ensures that a founder has a strong incentive to stay the course so long as the company needs his services.  Importantly, founder vesting also sets an example for the company, enabling the founders to tell all the employees they hire, who will be subject to vesting, that they have a similar arrangement.

It is not atypical for a founder vesting plan to have some differences compared to those of employees, and those differences can be very sensible.  Often, for example, founders vest without a cliff; a cliff is typically put in place to ensure a new hire does not leave after just a few months.

The key is that all the founders demonstrate their commitment to each other, to their employees and to the company.  Vesting their shares does exactly that.

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