Founder vesting: Your startup's safety net

We’ve all heard that most startups don’t make it in the long run, but the real question is, why not?

Running out of money, lack of demand and other obvious factors are in the mix. But one of the biggest risks lies in your nearest and dearest: your co-founders. 

Shockingly, 65% of startups face co-founder issues, often relating to how they’ve split equity and divided workloads. If you’re going for a 50/50 equity split, for example, both partners depend on each other to keep things fair and even. 

Promises might seem like enough, but more and more founders are implementing co-founder prenups that protect their ventures from disputes. 

The best way to do this is by implementing a vesting schedule, meaning co-founders effectively earn their equity. Vesting schedules incentivise cooperation, slashing the risk of disputes while building trust and cohesion. 

In this article, we’ll discuss vesting schedules for founders, how they work, and why these co-founder prenups are proving more popular than ever. 

Founder vesting explained

Imagine if someone bails out of the startup early. No one wants them unfairly walking away with a big slice of the company, right? That's where vesting comes in.

Vesting is a process whereby somebody gains ownership of their allotted shares incrementally over time – in this case, the founders.

It's a way to ensure founders earn their equity over time, keeping everyone committed for a mutually agreed-upon time period. This benefits all parties. It's all about aligning long-haul goals with sweet, vested rewards.

How does founder vesting work?

Let’s get down to the nitty-gritty of how vesting works in practice.

When a startup is formed, one of the first hurdles you and your fellow founders will face is deciding on an equity split. This defines each founder’s company share and influences future profits, decision-making power and responsibilities.

An equity split isn't a one-size-fits-all situation. With two founders, you can see why a straightforward 50/50 split might make sense. Equal input in, equal value out, right? Sadly, that's not always the case.

Throw three or more founders into the mix and it becomes even more complex, particularly if you’re taking on disproportionate workloads.

Once you decide how to split your equity, you can implement a vesting schedule. The schedule dictates how and when the founders' equity will become fully owned (or "vest") by them. 

This will be agreed among all founders and generally includes the following:

A "cliff"

A cliff is usually a one-year period during which none of the founders' equity vests. It acts as a trial period to ensure founders are committed to the startup before any ownership stakes are secured.

Gradual vesting post-cliff

After the cliff, equity starts to vest in increments (often monthly or annually) over a predetermined period, typically four years. You might see this expressed as, "four-year vesting with a one-year cliff".

This means that a founder earns larger portions of their equity stake as they continue contributing to the company's growth.

Milestones

You could also vest shares based on performance milestones. For example, raising revenue by X% might unlock X% of equity for founders. Milestone-based vesting could be combined with, or used instead of, time-based vesting. But we'll hasten to add that time-based vesting is your best friend; it keeps things simple.

Vesting schedules and their terms can be very flexible.

For example, co-founder Jack might be promised 40% of equity, but there's a catch – it vests over four years, and only if he sticks around in his role. Similarly, Elaine could earn her 40% share by keeping customer churn below a certain percentage over two years.

Of course, equity and milestones should align with each individual’s contribution and role within the company - something Mike Moyer breaks down in his Slicing Pie model.

(You can also work out how much equity to give each person depending on their role and when they joined with our free tool).

The benefits of founder vesting

Two (or more) brains are better than one, right? Well, two or three founder teams built 80% of billion-dollar startups, which certainly suggests so. Another study found that the perfect number of founders is 2.09.

However:

35% of startups lose a founder within ten years.

And a two-person team is twice as likely to dissolve as a solo-founded venture. These figures seem contradictory but essentially highlight the higher risks and rewards of co-founding.

Founder vesting is a powerful means of swinging the pendulum towards the rewards. Here are the benefits of choosing to vest founder equity over time:

1. Mitigating risks

Vesting acknowledges that not all ventures sail smoothly and that the dynamics within founding teams can change. By implementing a vesting schedule, you're putting a system in place that mitigates the risk of co-founding while strengthening the benefits.

2. Aligning incentives

The vesting structure ensures that your skin is in the game for a reasonable time. Vesting schedules don’t last forever, though – typically around four years – usually enough to gauge progress to key milestones, raise funding, and so on. It’s not about locking money away forever, but putting the startup’s success centre stage for a sensible period.

3. Reinforcing commitment

Beyond the stats, vesting embodies a commitment. It signals to investors, employees, and co-founders that you're in it for the long haul. Commitment is crucial in building a culture of trust and perseverance, qualities that define successful startups.

And what happens if I don’t use founder vesting?

Good question. We've uncovered a number of “founder horror stories” and there are several examples we can learn from.

For instance, Antje Danielson and Robin Chase founded Zipcar, agreeing on a 50/50 equity split, but disagreements led to a heated equity dispute and Danielson's eventual firing. 

In another case, Manish Maheshwari and Tanay Pratap had differing visions for Metaversity, an EdTech platform. They couldn’t compromise, leading to investor interventions and the company's collapse. 

There's the notorious dispute between Mark Zuckerberg and Eduardo Saverin, that underpinned the storyline for the film, The Social Network.

More recently, Cyrus Hodes, co-founder of AI company Stability AI, is currently suing ex-business partner Emad Mostaque for convincing him to sell his 15% stake for just $100 (£81) three months before the company achieved a $1 billion (£8.1m) market valuation - ouch.

A well-thought-out agreement can prevent relations from reaching breaking point and limit damage when things really go south. 

When founders depart: good leavers vs bad leavers

Let’s confront what happens when founders leave.

Most vesting schedules recognise that there are many situations when founders depart for legitimate reasons. The goal of founder vesting and equity agreements isn’t to penalise those who leave for valid reasons.

Instead, the terms of their departure and the impact on their equity are typically governed by good leaver and bad leaver clauses within the shareholders’ agreement. These clauses define the conditions under which a founder exits and how their equity is treated.

Good leaver clauses

Typically, good leaver clauses apply when a founder exits under favourable or neutral circumstances, such as retirement, ill health, or other personal reasons not detrimental to the company. In these cases, the departing founder can often retain a portion of their vested shares.

Any unvested shares may be subject to specific terms outlined in the agreement, such as accelerated vesting or continued vesting according to the original schedule.

Bad leaver clauses

Bad leaver clauses come into play under less favourable circumstances, like gross misconduct or leaving to work for a competitor.

These clauses can lead to the forfeiture of unvested shares and sometimes require the founder to sell back vested shares at a predetermined price, often lower than market value.

The intent is to protect the company and its remaining stakeholders from potential harm. Defining clear, objective boundaries for both vesting schedules and good and bad leaver clauses is absolutely paramount.

With Vestd, you can bake these clauses, a vesting schedule and other conditions into your agreements.

Introducing Agile Partnerships

Agile Partnerships - what we call co-founder prenups - are revolutionising how equity is shared in startups.

Agile Partnerships are a simple and cost-effective way to bring the many benefits of founder vesting to your business.

It enables you to set various conditions for co-founders, such as achieving milestones or staying with the company for an agreed-upon period. Think of it as a smart, fair way to ensure that all future gains are truly earned.

We saw a phenomenal 500% growth in our co-founder prenups in 2023, showing how more founders proactively protect their ventures against co-founder issues.

Remember, this isn’t about penalising anyone or locking their shares away. It's a win-win: your team stays motivated, and your startup's equity is distributed fairly and strategically.

For more information about Agile Partnerships and how to implement them, book a free, no-obligation consultation with an equity expert.

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