People use the term "vesting" to refer to a clause typically embodied in a founders' agreement in which the shares "vest," or become shares that you actually have a right of ownership over, if you continue to perform your duties.
Vesting schedules typically last 4 years with shares vesting quarterly or monthly.
So, you can think of it like this: After year one, you'll own a 1/4 of your 50%, or 12.5%. Year two, 1/2, or 25% ...and so on. You don't actually own the full 50% (i.e. doesn't "fully vest") until year 4.
Many vesting agreements carry a one year cliff, which means that none of your shares vest if you leave the company before performing for one full year. This is to prevent the "lazy founder" problem, where one founder is doing most of the work and the other one is goofing off, or decides to leave and take another job.
This is important because the first year is the most risky for a startup and requires all hands on deck. If someone flakes out, you can't have a big chunk of shares tied up in them. One, because it isn't fair. Two, because you likely need to go find yourself another founder or will need that equity for first employees. It scares off experienced founders and investors to see a chunk of your cap table trapped in a "bad decision" founder that flaked out. This same logic carries over to why there are vesting arrangements... you shouldn't be compensated if you abandon the company and don't put in the same work as the other founder.
Hope that helped explain what it is and the reasoning for it!
Vesting means that each owners shares of the company will be given to them over time so right off the bat neither of the people own an outright 50% stake.
for example a common scenario is a Four year vesting with a one year cliff, acceleration up any sale or liquidation event.
What this means in every day terms is that you own more shares each month you work, but if you leave before a year is up you own nothing. So if your half is 5 million shares then after the first year of working you will have earned 1.25 million shares after your first year which are now yours and cannot be taken away.
For each working month after that you will earn an additional 104,167 shares (its actually 166 2/3) until you have completed your 48th month at the company at which point you now own all five million shares, or are "Fully vested" as the term would imply.
It basically just ensures dedication to a project and that an early person who was involved with the company in some way does not come back 10 years later suing for "their half" of a company they may have helped start but had no involvement in product direction, success etc.
Vesting is just receiving the full rights of the share, option, or whatever over a specific amount of time.
If you start a company with someone you don't (er, shouldn't) just automatically get 50% of the company. That would allow you walk on day 3 and still own 50%. Instead you receive the ability to leave with your shares on a vesting schedule so that you have skin in the game.
The idea of vesting is to prove that founders can build value before getting rewarded with their stock. When founders start, they usually need to build in some form of vesting to prevent one of them from just walking away with a windfall while the others continue to work hard to build value in the venture. Even then, however, if founders have already build some value before the formal structure is put in place, they will take their restricted stock grants with some portions immediately vested (usually 20% or so, maybe up to 33%). At Series A, the investors might insist that founders restructure their stock positions so that they have to vest at least a significant part over some period. This can vary but usually means that the founders get cut back so that only, say, one-third of their stock is vested, with the balance subject to vesting over a few years. This ensures that the investors will not get screwed and that the founders will earn out their positions as they use the investors' money to continue to build value. Finally, at the M&A stage, the purchase price is sometimes divided between a cash/stock portion that is given outright to the stockholders and another portion (usually an option grant) that needs to be earned out. The basic idea behind such a division is that x amount rewards them for the value they have built and the balance will reward them for continuing to add value in the future. Usually, the x part is by far the largest part of the consideration, with the balance (the part that needs to be earned going forward) amounting to, say, 10 or 20% of the total purchase price.
The consistent theme in all such cases is to make sure that those who have built value get non-forfeitable equity as a reward while those who need to prove themselves going forward get equity that can be forfeited.
If you have built true value, then, of $10M and you take your payment in stock that is 100% forfeitable, you set it up where you can be cheated out of all the value you have built with little or no legal recourse.
This is a HUGE red flag. I have seen founders do such deals and have begged and implored them, at the very least, to insist on 100% acceleration clauses in their employment arrangements should they be terminated without good cause. In the one case where the founders went through anyway without such protection, the company (a prominent public company) wound up terminating one of the main founders within months and all he got was a few crumbs for years worth of effort.
Check with a good M&A lawyer on this and then use your best judgment. It is ultimately your call, whatever the legal risks. But do it with open eyes and that means getting good help in assessing what those risks are.
The stock vests over time. Four years isn't the typical time for stock to vest; it's the typical time to be fully vested. Usually it's 1/4 per year for 4 years.
Vesting doesn't just protect investors. It also protects cofounders. Suppose you start a venture 50/50 with a buddy. After a year, he leaves, and three years later you've bootstrapped the company into a $100m business. Without vesting, your cofounder would still be entitled to 50%. With vesting, he would get 25% of 50%, or only 12.5%.
Most employees of startup companies are given restricted stock with a typical 4-year / 1-year cliff vesting schedule. Aka - they have to be with the the company for 4 years to vest 100% of their shares (25% gets vested on the "cliff")
Moreover, if I were working with a co-founder, I would (and have) insist we vest on that schedule, and certainly not monthly from day 1.
There are a few reasons:
1. I don't want my co-founder leave before a year and having a chunk of the company. Likewise, I want to do right by my co-founder. If I leave before a year is up, it wouldn't be right for me to own a chunk of the company.
2. It's inequitable for the founders to have different vesting schedules than employees. What happens if someone joins the team pre-financing? If they get the same terms as the founders, then what about an early employee vs. a later employee? It makes for a weird, political situation.
3. It makes it easier to raise money. If you're vesting on the same terms as your investors they have no basis to negotiate over that term; they'll just check the box and move on. It passes the "blink test."
The company's ownership is divided in shares, also called equity. A cap(italization) table details the distribution of equity. In this example, 40.8% (= 51% * 80%) for founder 1, 39.2% (= 49% * 80%) for founder 2 (assuming it's OP), 10% for investor and 10% for something called options that may be granted in the future to new employees that allows them to buy shares of the company at a low price. 4-year reverse vesting with 1-year cliff means that if one of the founders leaves before 1 year of signing the contract, they are forced to sell at no profit (still, not $0) the entirety of their shares to the other shareholders. After 1 year of staying at the company, they may keep 1/4 of their shares and are forced to sell only the rest. Following that 1 year mark, they earn the right every month at the company to keep ~0.833% (= 40% / 48 as there are 48 months in 4 years) of their shares and forced to sell the rest. At the 4 year mark of staying, they are no longer forced to sell any of the initial set of shares. It does not apply to any future grants for which new conditions or new schedules may apply.
Context for folks who haven't encountered vesting before: vesting is an arrangement where, instead of getting all of your ownership up front, you earn it over time. For example, you might have a fairly common arrangement in Silicon Valley where you get 1/4 of your equity after working for a year and the remaining 3/4 over the next 3 years. This pre-commits to what happens regarding ownership if someone leaves 18 months (or 18 days) into running the company.
Atlas C corporations with multiple founders have a vesting schedule built-in (4 year vesting; 1 year cliff), the market standard in Silicon Valley.
Vesting in an LLC is complicated:
Because an LLC is a partnership, there can be complicated consequences of someone stepping back from an operational role (like e.g. being a founder) but remaining an owner of the business. We didn't think it was appropriate to have a one-size-fits-all answer for this: some companies might choose to buy out the departing founder, some might choose to pay them dividends on an ongoing fashion, and some might not have financial bandwidth to pay dividends but might want them to participate in upside in the event of a future acquisition.
This is heavily dependent on facts-and-circumstances.
Vesting is more of an established concept, with off-the-shelf support throughout the ecosystem, for C corporations. For those who want it in an LLC, please speak to an attourney. You can still adopt it for your Stripe Atlas LLC, it just isn't built in to the default experience.
I'm confused about your talk of vesting. Founders don't vest, they create the stock and sell/give it to others with a dollar amount or vesting schedule. Are you a founder or an early stage employee?
This is why it is so important to have vesting of founders shares. Then when they are no longer participating in the company there is an equitable manner for how many shares you end up with.
In my first company we arranged vesting over 4 years, 1/4 each year. Some people might prefer 3. Many investors will also insist on this as well.
I actually don't understand the straight 4 year vesting schedule for founders. It seems unfairly favoring the investors. For founders who have poured their hearts and souls into building product and market initially, they still have to wait for 4 years after accepting funding to get their full reward? And risk losing their work along the way? And yes, many founders have been forced out from their startups before their 4-year schedule.
For startups that have product and market before funding, it would be more fair to have a "regressive" vesting schedule, e.g. 25% immediately vested, 30% 1st year, 20% 2nd year, 15% 3rd year, 10% 4th year.
You guys should have had vesting in place. I am going to guess you didn't. Vesting is designed to protect founders for this very reason. Typical vesting is usually 4 years to earn the full 100% of their vested shares with a 1 year cliff.
So to break this down, lets PRETEND (i.e. example scenario) you guys started out as 50/50 partners. The way vesting would have worked would be, for simplicity sakes, let says there are exactly 100 shares and that suppose you both had vested the full term (4 years) and stuck it out, you both would have 50 shares each.
Typically if anyone leaves sooner, the way it works is, if you leave before the first year (hence 1 year cliff), you leave with zero equity. At the 1 year mark, you earn 25% of your vested stock (1 year of 4 year vesting period). That means 12.5 shares of stock (1/4th of your 50 shares). From that moment on, for the remaining 3 years, shares would vest 1/36th of the remaining share for each month that goes by.
Thus at the end of the 4 years, you are fully vested. In this case, I would treat this the same. You would need to do a termination agreement (you should talk to your attorney about this), give him any vested shares he would have earned or if he is leaving before he's been there for a year, and give him some additional compensation for the termination agreement you think is fair (not stock; usually cash). In either case, you are recommended to do a termination payout whether he gets stock or not.
Terrible idea, and based on the title of your blog, it's no surprise to me that you'd like all your equity in year one.
There are reasons for 3,4 or N year vesting - namely keeping employees invested in the business. If employees at a startup turned over every year, it simply wouldn't survive.
Salary is used to keep employees for a year. Salary and/or equity is used to keep employees for a meaningful period of time. There will always be the ones there to simply collect a paycheck, and likewise there will be ones who stick around for their 50,000 shares of equity without doing the math to realize their potential upside near 0.
Yes this is correct - apologize if I wasn't clear with this. From what I understand and my previous experiences at startups it was a standard vesting structure where ownership vests over 4-years with a 1-year cliff (or at an acquisition event). On day-1 neither I nor my co-founder had any shares vested.
If you have a 4-year vesting schedule with a one-year cliff, then anyone who walks away before 12 months have passed leaves empty-handed. Anyone who walks away before 48 months have passed will be giving up at least a little.
However, I think vesting only protects you from co-founders who quit. I'm not sure how you can deal with situations where a co-founder simply stops contributing (or only contributes an extremely minimal amount). HNers, and advice in this area?
On a related note, splitting the company equally might not be the best decision. People are different, and as a result will contribute differing amounts. Later down the road, you don't want anyone to feel like he's doing a disproportionately large amount of work. Sit down and agree on what you expect from each other in terms of time, commitment, and effort, and make sure the equity is split fairly based on that.
So, the percent isn't really enough to get answers; there's going to be a lot more information here.
But generally speaking, in American tech companies, the current norm is something like "a four year monthly vesting with a one year cliff."
If you have that, what that would mean was that you got no stock for your first year. If you got fired in month 11, you'd be out in the cold on equity completely. This is a safety measure for the company: you can't always be sure you're hiring the right person.
But if you get past the cliff, then you receive all the stock you would have gotten during that time.
A four year monthly vesting means that you break your stock up into 48 monthly groups, and receive it in those pieces one at a time. So, assuming the one year cliff, you'd get one quarter of your promise the day that cliff ticked over, then 1/48 of your promise every month thereafter until, after four years, it was fulfilled.
Meaning if you got a 1% offer (which is large,) and you got fired at exactly year 2 of a four year vesting, you would walk away with one half of one percent of the company.
There is a book that I read which I found very, very helpful in understanding the arcana. It's called "Venture Hacks," and despite that the title pretty obviously panders to software nerds, it is chock full of very valuable information, and is presented in a way that I found very, very readable.
It is quite uncommon for a company to give you a percentage up front. Hiring is difficult; sometimes a complete clown looks really sophisticated, and two months in, when you realize they basically just lied their way through the interview, you don't want to send them away owning a piece of your thing after having done nothing.
But, the amount of information you gave us is incomplete, so we cannot actually give you a solid answer.
Vesting schedules typically last 4 years with shares vesting quarterly or monthly.
So, you can think of it like this: After year one, you'll own a 1/4 of your 50%, or 12.5%. Year two, 1/2, or 25% ...and so on. You don't actually own the full 50% (i.e. doesn't "fully vest") until year 4.
Many vesting agreements carry a one year cliff, which means that none of your shares vest if you leave the company before performing for one full year. This is to prevent the "lazy founder" problem, where one founder is doing most of the work and the other one is goofing off, or decides to leave and take another job.
This is important because the first year is the most risky for a startup and requires all hands on deck. If someone flakes out, you can't have a big chunk of shares tied up in them. One, because it isn't fair. Two, because you likely need to go find yourself another founder or will need that equity for first employees. It scares off experienced founders and investors to see a chunk of your cap table trapped in a "bad decision" founder that flaked out. This same logic carries over to why there are vesting arrangements... you shouldn't be compensated if you abandon the company and don't put in the same work as the other founder.
Hope that helped explain what it is and the reasoning for it!
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