Nivi · April 20th, 2007
“During the whole funding process they said, ‘We’re interested in you guys because of your management team; we think you’re fantastic…’ Two weeks later they pull me into the office – before even the first board meeting – and say, ‘We want to replace you as CEO.’”
Summary: You made a commitment to the company by agreeing to a vesting schedule — the company should reciprocate and commit to you by granting acceleration upon termination.
Over time, your continuing contributions to the company will become relatively less important to its success. But the number of shares you vest every month will stay relatively large. Founders generally make their greatest contributions at the early stages of the business but their vesting is spread evenly over three to four years.
As your relative contribution to the company diminishes, everyone at the company has an incentive to terminate you and benefit ratably from the cancellation of your unvested shares. Nevertheless, in our experience, founders are allowed to vest in peace unless they are incompetent, actively harmful to the business, or clash with a new CEO.
You will probably be terminated if you clash with a new CEO.
By definition, a new CEO is hired to change the way things are and provide new leadership to the business. That he might clash with founders who previously ran the business is predictable. The CEO usually wins any disagreements or power struggles — he is the decider and he decides what is best.
The investors, board, and management will almost certainly agree to fire your ass if you continuously clash with a new CEO and you will lose your unvested shares upon termination.
Accelerate your shares if you are terminated.
50% to 100% of your unvested shares should accelerate if you are terminated without cause or you resign for good reason.
Cause typically includes willful misconduct, gross negligence, fraudulent conduct, and breaches of agreements with the company. ‘Clashing with the CEO’ is not cause. Good reason typically includes a change in position, a reduction in salary or benefits, or a move to distant location. Detailed definitions are included in the Appendix below.
Make sure you receive this acceleration whether or not your termination or resignation is in connection with a change in control of the company, such as a sale of the business. You can clash with your acquirer too.
Justify acceleration with the reciprocity norm.
Acceleration may cause consternation among your investors but it is easy to justify:
“A founder’s most important contributions generally occur in the early stages of a business but he earns his shares evenly over time. If I clash with a new CEO and he terminates me, I should receive the equity I earned with those contributions. Which will make me much more comfortable with hiring a new CEO.
The founders agreed to a vesting schedule to demonstrate our long-term commitment to the business. You have told us that the founders are critical to the company — that we are the DNA of the business. Acceleration demonstrates the company’s long-term commitment to our continuing contribution.”
This argument is an application of the reciprocity norm which requires your opponent to be fair to you if you are fair to him. Your vesting schedule locked you into a commitment to the company — that was fair — now acceleration locks the company into a commitment to you.
It is even easy to justify 100% acceleration if you are the sole founder of the business:
“Right now, I own 100% of my shares. After the financing, I will have to earn these shares back over the next four years — I’ve agreed to that. But if I’m removed from the business, I lose the right to earn my shares back. In that case, I should walk out the door with the shares I came in with.”
Avoid unfair termination with a democratic board.
As usual, the best way to avoid unfair termination and avoid hiring a bad CEO is to create a board that reflects the ownership of the company with hacks like making a new board seat for a new CEO.
Acceleration for co-founders can do more harm than good.
If you have a team of founders, acceleration upon termination can do more harm than good.
A co-founder with acceleration upon termination who wants to leave the company can misbehave and engender his termination. If the company decides to terminate him without cause to avoid possible lawsuits, your co-founder will walk away with a lot of shares. In California, it is actually very difficult to prove cause unless an employee engages in criminal activity.
If you trust your co-founders absolutely, you should negotiate as much acceleration upon termination as you can. Otherwise, you need to decide which is worse: the expected value of misbehaving co-founders who leave with a lot of shares or the expected value of leaving a lot of shares behind after your termination.
What are your experiences with vesting upon termination?
Submit your experiences and questions on vesting upon termination in the comments. We’ll discuss the most interesting ones in a future article.
Appendix: Definitions of ‘Cause’ and ‘Good reason’.
Your lawyers will help you define cause and good reason. Definitions that we have used in term sheets in the past follow. Note that the definition of good reason below assumes the company plans on hiring a new CEO at some point:
- “Cause” shall mean the occurrence of:
- The willful misconduct or gross negligence in performance of his duties, including his refusal to comply in any material respect with the legal directives of the Company’s Board of Directors so long as such directives are not inconsistent with a party’s position and duties, and such refusal to comply is not remedied within ten (10) working days after written notice from the Company, which written notice shall state that failure to remedy such conduct may result in termination for Cause;
- dishonest or fraudulent conduct, a deliberate attempt to do an injury to the Company or the conviction of a felony; or
- breach of the Proprietary Information and Inventions Assignment Agreement entered into with the Company.
- “Good Reason” shall be deemed to occur if:
-
- there is a material adverse change in employee’s position of employment causing such position to be of materially less stature or of materially less responsibility, including without limitation, a change of title or responsibilities normally associated with such title, without employee’s consent (other than, with respect to the Founder(s), a change, in connection with the appointment of a new CEO, to an executive officer level position with normally associated responsibilities that reports directly to the CEO or the Board of Directors),
- there is a reduction of more than ten percent (10%) of employee’s base compensation unless in connection with similar decreases of other similarly situated employees of the Company, or
- employee refuses to relocate to a facility or location more than sixty (60) miles from such employee’s principal work site; and
- within the one (1) year period immediately following such event the employee elects to terminate voluntarily his employment relationship with the Company.
Very interesting post.
In 2004 I turned down funding from a VC because of a vesting requirement. It was obvious that the new VCs wanted to replace me as VC and it was probably time to take that step. The issue was that I had backed the company myself for two years and then had angels in the business for 12 months. In my view I had earned the equity – we were not a newly minted company with no product or customers.
So I turned those VC’s down and accepted an offer from a different bunch. I still got s***ed over.
I went to these VCs with a new CEO candidate whom I had worked with for 12 months previously. The investment proceeded and I stepped aside. Four months later I was asked if I wanted to leave and sell my shares. The offer was way below the value of the previous round so I said I would leave, but retain the shares and a board seat. However, they really wanted me gone. The deal was I would be terminated without cause, but loss of employment meant loss of board seat, which meant no ability to protect my shareholding (about 20% at that point). I was actually told by the CEO (a buddy?) that they would engineer a down round just to force me out.
Eventually we reached a compromise, but the lessons learned were:
1. Resist vesting if you have devoted time and your own capital to a business prior to VC investment.
2 Have a board seat linked to the shareholding, not the employment contract.
A founder, you failed to learn the most important lesson at all:
VCs are dumb money. They will screw your business over.
Every successful VC backed company is a business that succeeded *despite* being forced to make bad decisions by their VCs.
Its logical- if VCs knew anything about running businesses, they would be running businesses, not managing teachers money for a no-effort fee.
NEVER, EVER, let a VC buy a share of your company ,and then get away with taking the rest by making you vest.
How about this– if you vest, they vest. If you are pushed out, all of their remaining shares that have not yet vested, go to you as part of your serverance.
Now that would align people’s interests.
After all ,when a VC invests, they are buying value that *you* created.
Easier to just not deal with VCs– their time ended in 2000. They are no longer necessary.
Hi,
Can someone please explain how a VC can make your equity worhtless by doing a down round?
I was forced out of the company but still have some vested equity (around 6%). I understand that it can get dilluted, but I always thought that it get dilluted equally for all shareholders. Can the VC and the existing management really leave me with nothing? My lawyer told me that this would not happen, but I am starting to doubt my legal advice now.
How is equity given to founders, after the vesting period (or 3 or 4 years) is over?
I assume they would be getting additional grants, but (given the relatively less value due to more employees, lesser risk, etc) they options that the would be vesting after the first 4 years, would be miniscule compared to what they got in their first 4 years, right?
To give an example, wouldnt the founders of some company thats dragging along in their Series E or F round, be getting much far lesser options per month nowadays compared to what they were getting in the first four years? So, why dont they just pack their bags and go start another company and get the initial gusher of options (leaving aside emotional reasons)?
Hacker,
If the company has done down rounds, the founder’s existing ownership may be small. So new grants for critical founders after 3-4 years could be relatively significant.
Even without vesting, founders may stick around to try to increase the value of the shares they already own. This is the beauty of giving people stock. Even after you stop paying them, they still do work for you because it makes their stock more valuable.
What about incentive-based vesting? Meaning, especially for an early-stage, pre-profit company, wouldn’t milestone vesting make sense as an alternative to cliff or re-vesting?
If you are a founder and the VC wants you to re-vest, why don’t you put your vesting where your mouth is and negotiate milestones into your employment agreement whereby certain measureables (whether EBITDA or achievement milestones) are used to accelerate your vesting?
I need some advice. I am one of 5 co-founders in a startup. We distributed shares to 3 technical co-founders and 2 business co-founders (i am a business co-founder) at founding. Now i am leaving to pursue another startup, but i will stay on as an advisor. our stock agreement states that if you are an advisor, you still vest. but the CEO wants to reduce the number of shares i own, so i still vest, but lose 50-75% of my shares. is this fair? my understanding of the issuance of “sweat equity” is that it is for the value added at founding, and not dependent on future involvement. I believe the company should just allocate more shares to the founders staying on. in lieu of that, a reduction seems reasonable, but if the reduction is not agreeable, is it better for me to seek a separation and take 50% (per accelaration described above, which we have in place) of my share and part ways? thanks.
co-founder about to go:
I don’t the details of your situation, but as a co-founder and CEO of three startups, I would share the same sentiment as your CEO. If you are leaving a startup, you are no longer fighting the war and will no longer play a direct role in the long-term success of the company.
Also, I am surprised to hear that you get accelerated vesting if you voluntarily leave. I think that is generous and if you have that, I would be grateful such a provision exists.
I met with a successful entrepreneur today who said this term saved his co-founder’s butt many years ago when he was terminated. It works. =)
Thx for creating a great resource.
So I have just noticed that my Series A Founders Stock Restriction Agreement appears to contain the dreaded provision to repurchase my VESTED founders stock in the event that I am terminated for cause or decide to leave voluntarily before the full vesting is up after 3 months. Ug.
Were I to decide to leave in that period do I have any other options aside from trying to get terminated without cause?
that should say “after 36 months”
After 10 months, our VC consortium decided to stop funding the company of which I was the sole founder. My shares vested at 1/48th per month. However, the company is still going after they asked me to leave a month ago. Should I ask for repurchase of the shares I already paid for but are not vested? They have not offered to do so. Also, I have not seen, though I have asked for, verification that the licensing of technology reverted to the university from which I resigned to start the company.
Any additional advice?
Those both sound like reasonable requests. I would hire a lawyer who has experience with termination in startups to guide you through other issues.
Wow, I really appreciate this post. I’m in a dilemma. The VC is taking a controlling stake in the company, board control and applying a new CEO. The new CEO has already made it clear that he doesn’t like me.
I’m currently the majority shareholder and founder of the company. They are playing really hard on a Termination Without Cause, where there is absolutely no severance guaranteeing my employment.
They claim that the severance will hinder the companies ability to raise money.
What would you do? Is fully accelerating stock the only other protection option here?
Get a very competent lawyer. It sounds like you’re on your way out. I suppose they could also give you cash severance.
Don't blow up your Series A term sheet by over-optimizing terms | A View from the Valley // May 8, 2010 at 8:16 pm
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