Anyone who has ever asked a lawyer a question, regardless of the topic, knows that the answer is almost always “it depends.” The answer is no different when it comes to the discussion about vesting schedules for founders shares, but the following should shed at least a filtered light on the subject.
In most cases, founders come up with the idea for the company, generate the initial intellectual property, and get the corporate ball rolling. Then, along comes an investor who pours capital into the company and suddenly the founder’s ownership interest in the company is worth something. The investor is afraid that the founder is going to (1) take the money and run or (2) get bored and play Animal Farm all day instead of maximizing the investment.
If the founder has restricted stock, the investor can rest somewhat-assured that the founder has an incentive to stay with the company for at least the length of the vesting schedule and the company is better protected in a situation where the founder needs to be removed. Investors have a vested interest (see what I did there?) in keeping the founder(s) with the company, as founder-led companies have been significantly outperforming management-led companies, particularly in the technology industry, as shown in the following graphical analysis from Reuters.
Can you imagine a dating strategy where you discuss how the break-up will go before agreeing to the first date? While this might lead to a lonely personal life, applying the strategy to business can save a lot of heartache. Establishing vesting schedules for founders shares forces the founders to jointly plan out how they want the business to go and grow, but also to account for the undesirable and the unthinkable in order to better protect their joint-baby, Company. Even if a company has a single founder, it’s advisable to consider with your attorney whether a vesting schedule is appropriate for your founder’s shares as it may be useful for attracting future investors, co-founders, or key employees.
The 1980s as a decade brought so many trends, (many of which are shockingly back in style… sorry, not sorry, about the scrunchie), including the gold standard 4-year founder’s vesting schedule. Startups, in an attempt to mirror the five-year vesting schedule of pension plans while gaining a competitive edge, normalized a 4-year vesting schedule with a 1-year cliff on founder’s shares. After one year of service, the founder is typically entitled to retain 1/4th of their shares, and then the remaining shares vest on either a monthly or quarterly basis thereafter for the next three years. While this is still the off-the-shelf standard vesting schedule, new trends in the tech industry suggest that maybe it shouldn’t be.
Given that the lifecycle of the average tech startup is trending longer from founding to exit than four years, it may be time to reconsider this time frame. Depending on your strategic goals, 7-10 years may be more appropriate. Concerned about signing up for a longer vesting schedule? Bust out your metaphorical glue sticks and glitter and get creative; consider a combination of time-based vesting and milestones that reward you for specific achievements like sales goals, strategic partnerships, and industry accomplishments. Your restricted stock agreement should also contain an acceleration clause that will accelerate vesting immediately upon a change of control situation where the company is bought/acquired.
The key take-away? Instead of skimping on the upfront legal fees during your entity formation phase, use your time and resources to thoughtfully consider your strategic goals and partnerships of tomorrow and how those should inform your company’s structure today.
This blog was written by Hunter Business Law Attorney Haley Lemon.
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