Updated: Dec 15, 2022
By Anishka Prasad - Head of Strategy & Operations – Future VC
Early-stage start-up structures are nearly always unique to the founder(s) that conceive(s) the business. In the excitement of coming up with a unique business idea that founders cannot wait to share with the world, a critical element of ensuring a sustainable long-term business, often goes amiss. This being the placement of a vesting agreement amongst initial founders and salary discussions that ensure good faith practices are enforceable as the company scales over various fundraising rounds.
Founder/Co-Founders and Vesting:
Founder vesting is essentially an agreement defining how stocks are issued, while all the founders are dedicated to the business. Should any of the initial team of founders decide to leave the business at any stage, without a vesting agreement in place, this can significantly damage the life of the start-up from progressing forward. For instance, in a team of three co-founders in a business with a 25% spilt in equity, (along with considerations such as option pool and external investors) should one of the co-founders have a change of heart in being involved in the business and leave, this situation could mean that remaining founders in the business are short-changed from the other’s exit.
Also, in some instances, the remaining team are left to deal with dead equity and an inevitable need to restructure the cap table in subsequent investment rounds. This scenario is not necessarily the end of a business. However, it can certainly be a lot more work for the remaining team, in terms of restructuring the company and sometimes, redistributing operative responsibilities as well.
To delve into the intricacies of various stages, and how vesting mechanisms play out in a start-up’s lifecycle, its crucial to plan for each stage as the company grows.
How does vesting work?
In the initial stages of a company, it is highly recommended that founders and operators agree to have in a standard shareholder’s agreement. A typical agreement usually has terms such as a 12-month cliff and a 4-year vesting period, which determines vested amount based on the duration of employment served by the founder or operator. Having this said, many founders could have a longer waiting period on either their cliff or vesting period as well, depending on the company’s specific structure and the terms agreed upon by the parties being involved. The basic concept behind a vesting schedule is usually straightforward, as portrayed in the diagram below, whereby, the term one serves in a company translates to the shares vested, and if a founder/operator choose to exit pre-term, then they forfeit the opportunity of benefiting with 100% of their vesting rights.
Who benefits from (Employee Share Options Plan) ESOP /stock options? (UK Examples)
· An opportunity to share directly in the company’s success through stock holdings
· Ownership Pride - employees may feel motivated to be productive with their ownership stake in the company
· Tangible representation of how much their contribution is worth to the employer
· Depending on the ESOP structure, it may offer the potential for tax savings upon sale or disposal of the shares.
· Enterprise Management Incentive Scheme - EMIs work by giving employees the option (i.e. the right) to buy shares in a company at an agreed price after meeting certain requirements, e.g. performance and/or service period. The agreed price can be the AMV (Actual Market Value) at the time of grant or a discounted value.
· Key tool to recruit the best and the brightest in a worldwide competition for top talent
· A chance to boost employee job satisfaction and financial wellbeing by providing lucrative financial incentives
· Incentivizes employees to help the company grow and succeed with a shared vision
· In some instances, ESOP may be used as a potential exit strategy for owners
Vesting and Salaries:
The importance of a vesting agreement is a prudent risk mitigation tool that should be exercised by founders and operators at the earliest stage of the company possible. Another equally important consideration take by founders and operators is salary lock in and review terms with each fundraising round. This not only maintains a certain level of mutual commitment and accountability between initial team members, but also aims to prevent any chances of future disagreements salary expectations and alterations that may fall outside of the agreed review timeframe.
Disclaimer: The information presented here on vesting schedules offered by this article should not be considered as financial or investment advice. It may not be suitable for all founders, operators, or investors. If you have any doubts, you should seek advice from an independent legal or financial adviser.