Here’s Everything You Need To Know About Founder Vesting

What Is Founder Vesting?

Founder share vesting means that a founder may keep a certain percentage or all of their stocks or shares only after leaving the company post a specified period or event. 

A one-year cliff is generally used, which means that a founder must be with the company for at least a year for their employee stock options to convert into shares. This prevents the founder from keeping all of their shares in the event they leave before completing a year. If this happens, the business can buy back all of the founder’s shares at the original price. 

For instance, Rohit gets 1 Lakh shares as a cofounder of a business and he decides to leave right at the one-year mark. Now, if 25% vesting was agreed upon, he would get 25,000 shares. The remaining 75,000 shares can be purchased by the company at the pre-agreed price.  

What Is A Founder Vesting Schedule?

The founder is granted stocks on the face value on a particular date. However, they cannot sell or utilise these stocks on the grant date. Instead, they need to wait for these stocks to be vested completely.

Generally, a vesting schedule lasts between three to five years. However, this time can depend on the share option and the company issuing it. 

What Are The Different Types Of Founder Vesting Schedules?

There is no one-size-fits-all vesting schedule to use. There are variations as per the kind of company, industry and size of operations. 

Reverse Vesting Schedule

Here, 100% of the shares are awarded to the founders on day one. However, the company can buy back these shares if the founder exists before the vesting period ends. Founders do not have total control over the 100% of the shares awarded until the end of the vesting period.

Cliff Vesting Schedule

Here, shares are generally accrued and not awarded before a specific date. The standard vesting schedule is four years, with a one-year cliff. 

Graded Vesting Schedule

A graded vesting schedule allows founders to receive incremental ownership of stocks over time. 

What Makes A Founder A ‘Good Leave’ And A ‘Bad Leaver’?

A founder is termed a ‘bad leaver’ if the employment is terminated due to misconduct, breach of material possessions of the shareholders’ agreement, fraud, commission of an offence involving moral turpitude and embezzlement related to the business affairs. It often involves the forfeiture, purchase or buyback of the departing founder’s locked and unlocked equity at the acquisition cost. 

A founder who leaves on agreed terms or because of unjust treatment by the company through no fault of their own is a ‘good leaver’. In such a scenario, the founder usually keeps their vested shares. The business can buyback the unvested founder shares at a price based on the greater of the fair market value (FMV) and the subscription price paid for such shares (which is usually nil or a nominal amount). 

What Factors Should A Business Consider While Allocating Stocks?

When determining the vesting schedule and stock allocation for founders, the business should consider the following: 

1. Time spent by each person on developing the business plan and if one person spent significantly more time than the others
2. If a significant gift of intellectual property, such as substantial work towards a patentable innovation or a pending or issued patent, has been made by an individual
3. The number of work hours each founder will devote to the business