Email from a startup whose founders have been working on the company’s product for months prior to incorporating:
“Hey, Foundry: what are your thoughts on not including a vesting schedule for our founder shares?”
At Foundry, we frequently receive questions like this, as the implications of vesting schedules for founder shares is a decision that virtually every new business will need to decide. For this blog, we are taking just about shares in a corporation, but the same ideas can apply to units in an LLC.
To start, when determining whether to vest or not to vest founder shares, the two questions that may help you decide are:
(1) Is your company going to seek outside funding?; and
(2) Would it be detrimental to the company if a founder(s) leave the company in one, two, or three years?
If you answer “yes” to either question, then having founders on some vesting schedule is a prudent decision for you and your company.
“Why is funding something we should consider when determining whether to put founders on a vesting schedule?”
Simply put, investors want to ensure you and the founding team are putting their money to good use and are in it for the long run. This is especially true in the early stages, when investors are typically investing in you, the founders. From an investor’s perspective, founders are more likely to stay committed during the early stages when their shares have yet to fully vest versus if all the founders’ shares have vested outright.
Also, depending on your company’s position with potential investors while raising money, you may find yourself in a situation where the investors in your company require founder shares to be on a vesting schedule. If your founder shares aren’t already on a vesting schedule or there isn’t much time left to full vesting, then investors may make their investment contingent on your shares becoming subject to a vesting schedule as part of the terms for the deal. This can turn into a negotiation; therefore, getting on a solid vesting schedule from the beginning can help.
“What if we just shorten the time on when the shares vest?”
As with no vesting schedule, watering down vesting schedules with shortened time frames and vesting terms is also a concern for investors. However, even if you have no intention of seeking outside investment, before taking this route, the company should ask itself whether it can continue optimally without a founder(s) in one, two, or even three years. Put differently, If you expect your business to take a year or two before it truly gains momentum (because you’re building software, brewing alcohol, growing an agriculture commodity, waiting for permits, etc.), then you’ll want to make sure either the founders are incentivized to stay or, at a minimum, don’t walk away with a large percentage of the company during a crucial time.
“We want some shares now to reflect the progress we’ve made up to this point. Is there any middle ground?”
There is no one size fits all middle ground. One option is keeping a standard four year vesting schedule and inserting a retroactive vesting start date to reflect the work founders put into the company prior to formation. Another middle ground is vesting a certain percentage outright with no cliff and then vesting the remainder for three years in monthly increments. These are some of the most common options we see. However, the option that is best for you and your company will depend heavily on a variety of factors unique to your situation.
There are pros and cons to any decision but putting in the time in the early stages to determine what is best for you and your company will pay dividends down the road.
Foundry Law Group is Here to Help!
The attorneys at Foundry Law Group have significant experience setting up solid business foundations and navigating founders and teams through crucial early decisions. Contact us with your questions, we’re here to help!