Andrew Eisenberg, Partner, Lee & Hayes
When a company is set up, there are many aspects to consider; one such aspect is the allocation of company shares.
Many founders dislike the idea of vesting shares to founders, themselves, and, instead, grant shares outright. The problem is that it’s very common for at least one founder to leave a company early on – whether it’s a disagreement, a change in circumstances, or a dream job.
The number of shares a founder keeps is a common source of hostility. There are two sides to the coin: the parting founder believes they have put in the hard years and are entitled to their shares, while the remaining founders feel that a portion of the shares should be returned to the company since they will have to carry on putting in the hard years.
Ultimately, it all comes down to one question: Why did the founder receive the shares?
Founders should receive a portion of shares based on what they have contributed – whether it’s an idea, investment money, hours worked, or for patent assignment. Founders need to discuss who has brought what to the table.
A vesting schedule is important!
Once it has been decided what portion of shares each founder will receive, the next step is to decide how many shares and on what schedule they should be earned for future contributions to the company.
By putting in place a vesting schedule, it means that when a founder decides to leave they will receive shares for their initial work – but shares that are not yet earned via continued involvement are reclaimed by the company.
The benefits of vesting shares for the company:
- It encourages founders to stay committed.
- It prevents founders from leaving and reaping the rewards of acquiring ‘unearned’ shares.
- It allows the company to reclaim shares that could be granted to the individual(s) replacing the departing founder.
The benefits of vesting for those outside the founding team:
- It shows investors that founders are committed.
- It convinces employees that founders have a long-term view for the company.
- It can aid in building better team attitude amongst employees and founders.
Typically, employees who join a company after the founders are placed on a vesting schedule. By having founders on vesting schedules, too, new employees are more receptive to the idea. It helps to foster a ‘team sport’ attitude and ensures everyone is giving their all.
Acceleration on exit
A hot topic at present is the acceleration of vesting shares upon – or just prior to – a successful exit event. Many attorneys are moving away from acceleration clauses or reducing the amount of acceleration, believing that founders need to create investor-friendly company when drafting the formation documents to assist the company in securing funding.
Ultimately, an investor will receive a higher payout on a company without acceleration, in comparison to a comparable company that does. While this is true, no two companies are truly equal and investors don’t make decisions solely on this fact – they look at a host of other factors.
In some cases, no acceleration at all actually has the potential to cause long-term harm. Looking past the investor stage to the exit stage, when a purchase event occurs, key employees are retained by the purchasing company. This is often important, to ensure knowledge transfer. The combination of an upcoming purchase event and no acceleration prior to a vesting period could mean that a key employee leaves. In some cases, this could reduce the valuation of a company or even kill a deal.
On the flipside, if the key employee has an acceleration clause and can earn the remainder of their shares for staying an extra month (and therefore to complete the purchase event), they probably will. Although the risk is small, the loss of an exit event could be disastrous. In this case, the acceleration may help to ensure an exit event remains viable throughout the negotiation period.
When founders choose to limit or forgo acceleration altogether, friction can occur. For example, if a company expands or achieves certain goals quicker than expected, founders could be in the position where their company is a few years ahead of where they thought it would be (and therefore ready for an exit) – yet the vesting schedule is behind the company’s trajectory. This can leave those involved with just 20 percent of their shares vested when the company is primed for an exit, rather than closer to 100 percent.
The conclusion? It’s important to remember that your company is for you, not the investor. Acceleration clauses can be used to reward yourself and key employees!
About the Author
Andrew Eisenberg is a partner with Lee & Hayes in the firm’s Austin office. Andrew’s practice focus on Corporate and Intellectual Property with an emphasis on aligning startup legal strategies and the company’s long term business goals. Andrew can be contacted at firstname.lastname@example.org or 512-456-5140.
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