What is vesting for founders’ shares?

The standard for startups is to put vesting on the shares issued to the founders. Our recommendation is to put vesting on the shares. Here’s what you need to understand:

The Principle: Vesting is placed on founders’ stock to make sure they stick around and work to earn the full value of their shares. You wouldn’t want to give 50% to your co-founder, only to have him get bored and leave and still own 50% of the startup.

The Mechanics: When shares are issued to the founders, the company will have the right to repurchase these shares if the founder leaves because he gets bored. However, this right of repurchase of the company will LAPSE or expire over time. Vesting for founders’ stock refers to the lapse or expiration of a company right to repurchase over time. In other words, the company’s right to take back the shares will gradually end as the founder earns the right to keep his shares. The standard vesting schedule is a 1 year cliff for 25% of all the shares and then 1/48 th of the total amount for each month thereafter until it is fully vested after 4 years.

Here’s a practical example to help you understand: If Peter gets tired of James and John two months after starting Hashbrown, Inc., then this vesting mechanism will protect James and John because Peter hasn’t earned the right to keep any of his shares. The 1 year cliff of 25% has not passed. If Peter leaves, the company would repurchase or buy-back all of Peter’s shares at the original purchase price.

Here’s another example: Let’s assume that Peter was originally issued 1,000,000 shares and he gets bored 1 year after starting Hashbrown, Inc. Under the standard vesting schedule, only 25% of Peter’s shares of common stock have vested. Or more accurately, the Company’s right to repurchase Peter’s shares has lapsed for 25% of the shares, or 250,000 shares of common stock. Peter would own outright 250,000 shares and the company could only repurchase 750,000 shares, and Peter would continue to hold 250,000 shares. He “earned” the 250,000 shares with 12 months of service and the Company’s right to repurchase has lapsed for these shares.

Bottom Line: The standard is to place the 4-year vesting schedule on founders’ shares. Investors will be looking for this to be in place. We advise staying with the standard unless there is a good reason to do otherwise.