Vesting Posts

Every team member of AngelList is on a 6-year vesting schedule. Including the founders. Why?

Because it takes a long time to build something important. And we want everyone to stick around for a long time.

Because we want people who are here for the mission, not a payday.

Because it sells prospective hires: the team you’re joining isn’t going anywhere.

Does that mean I get more equity?

Everyone asks whether they get more equity to make up for the longer vesting schedule. A good way to think about that is whether we would give smaller grants if new team members were on a 4-year schedule. And the answer to that is ‘yes’.

There are a lot of benefits to getting additional equity now, instead of 4 years from now:

  1. The strike price is today’s strike price, not a higher strike price 4 years from now.
  2. The clock on long-term capital gains starts as soon as you exercise the grant.
  3. A new grant 4 years from now wouldn’t be as big.
  4. Any acceleration is likely to consider the entire grant, not a smaller 4-year grant.

If you’re interested in a 6-year vesting schedule, AngelList is hiring engineers and designers.

Related: 1-(wo)man startups and Ask forgiveness, not permission

Comment on Hacker News →

Thanks to Atlas Venture for supporting Venture Hacks this month. This post is by Fred Destin, one of Atlas’ general partners. If you like it, check out Fred’s blog and tweets @fdestin. And if you want an intro to Atlas, send me an email. I’ll put you in touch if there’s a fit. Thanks. – Nivi

If you believe the blogosphere chatter, the entrepreneur-VC relationship seems strained like at no time in the past. The discussion seems to veer towards the “good versus evil” myth of creepy financiers intent on screwing polymath entrepreneurs out of their hard-earned wealth. Good-versus-evil is not a very constructive way of framing complex debates (remember “the war on terror” and the “axis of evil”?). Most sour VC-entrepreneurs relationships are simply partnerships gone bad, and divorce is never a pretty experience.

I see a lot of misguided commentary out there focused on the wrong issues, such as “how can you ask for liquidation preferences and call yourself entrepreneur friendly?” I am happy to answer that one if you are interested.

What I wanted to do here instead is focus on a few of the clauses that entrepreneurs should absolutely avoid; the wrong tradeoffs which later expose them to really “losing” their company. There are rational explanations for all of these, but as we know hell is paved with good intentions. Here are some of the pathways to hell:

Now we own you: Full ratchet anti-dilution

Anti-dilution says “your company has no tangible value and as result I accept 20% ownership today but if we don’t create value I want some protection on potential share price reduction”. This protection is embodied in a clause called anti-dilution protection which results in additional “bonus” shares being issued where there is a down-round, i.e. a subsequent financing at a lower price per share. You can attack this clause conceptually but if VCs did not have any form of anti-dilution they would set the initial price lower. In other words, you as entrepreneur are getting less diluted today but with some ownership risk if company value goes down (at least that’s the theory, would be interesting to see how prices adjust without anti-dilution).

Anti-dilution is usually mild. Broad-based weighted average anti-dilution says that a number of anti-dilution shares are issued (or the conversion price of the preference shares is adjusted) based on a formula nicely explained by Brad Feld back in 2005.

Here is how you can get really screwed: there is one version of anti-dilution whereby the number of shares issued to the investor is FULLY readjusted if subsequent financings are downrounds. Say you raise $1M at $10 per share and hence issue 100,000 shares to your VC, in exchange for 10% of your company. The next round is at $5 per share; the original VC now gets an additional 100,000 shares issued; in the original cap table, he now owns 20% of your business, before the new money comes in.

This gets nasty when serious money has been raised. Imagine the following happens: the pre-money valuation on your next round is less than the cash you raised previously. Say your company is in difficulty and raises $10M at $10M pre-money, having raised $10M previously. Because the anti-dilution calculation is iterative, guess what, the share price mathematically converges to… zero. Legally it will be set at the par value, say €0.0001.

Your ownership just evaporated.

If your VC understands how the world works, you will sit around the table and hammer out some deal. But your negotiating position is weak. If on top of that a new CEO has been hired, the rational optimisation is to keep as much equity free for the new sheriff in town and not for the original entrepreneur. You are now relying on people’s ethics, sense of fairness, or belief that long-term you don’t build venture firms by screwing entrepreneurs. In, say, 75% of cases, good luck — few people really believe in win-win in these situations.

Note that there is usually a shared responsibility in full-ratchet: the entrepreneur is obsessed with maximising the headline number and accepts anti-dilution as a tradeoff (“OK, I will agree to this silly price but you better not screw up”). Often a Pyrrhic victory.

“Thank You and Good Luck”: Reverse vesting without good leaver clause

First, let me state that reverse vesting matters to me. I would not do a deal without some form of reverse vesting. Here’s why: I invest in three founders, two of which work hard and one of which decides to leave to open a restaurant. I (and his co-founders) are screwed. The guy or girl who left gets a free ride on the back of everyone else. He needs to be replaced, for which additional stock options are required. This is why reverse vesting exists.

The usual reverse vesting that you will find in our term-sheet is: quarterly reverse vesting of founder stock over 4 years. This is watered down or adapted based on individual circumstances.

I have seen cases where reverse vesting is not qualified: you leave the company, you lose your stock. That is a very toxic clause, and you should never accept it. You are now fire-able at will and there is even an economic incentive to do so. Unfair and abusive.

So don’t find reverse vesting per se, but fight on the details. Can a percentage of your stock be considered yours? Probably. Make sure there is a good leaver / bad leaver clause. You get fired for cause, you lose some. You decide to leave, you lose some. The company decides it does not want you around anymore, you keep it. The need to be watchful of the details; sometimes you will be asked to sell your stock at “fair market value” when you leave, or at last round price etc. Negotiate hard.

Continued in Part 2 with limited exercise period options, multiple liquidation preferences, cumulative dividends, and the trap of complexity…

If you like this post, check out Fred’s blog and his tweets @fdestin. If you want an intro to Atlas, send me an email. I’ll put you in touch if there’s a fit. Finally, contact me if you’re interested in supporting Venture Hacks. Thanks. – Nivi

How common is accelerated vesting on change in control (AVCoC)? Noam Wasserman from HBS has the answer in Unlocking Your Golden Handcuffs:

“I recently got an email from a serial entrepreneur who has been brought on as the head of finance and operations in a mobile-services start-up. One of his questions was: How often do new-venture executives get AVCoC? If it’s not common for them to get it, he wouldn’t push for it and would focus his negotiating leverage on another term, but if it’s common, he wanted to push hard for it. (He felt that the start-up might be the subject of M&A activity in the future, and had already experienced working for a large company after a prior venture of his had been acquired.)…

“Overall, the percentage of executives receiving AVCoC was 65.5%. However, as shown in the chart below, the percentage varied from a high of 76.4% for CEOs down to 46.3% for the Head of Human Resources. (I only show the positions for which I had at least 100 data points.)…

“I also analyzed AVCoC at the team level, which is the focus of your first (“side note”) point. At the team level, 36% of the teams (429 ventures) had a “mixed” approach to AVCoC, wherein some executives had AVCoC and some did not. In those ventures, executives would seem to have been negotiating AVCoC on a case-by-case basis, in the absence of a consistent plan adopted across the team/venture. Of the other ventures, 47% (561 ventures) had AVCoC across all of the executives in the survey. Those 47% might include some ventures that adopted a consistent plan and others where the AVCoC’s were put in place on a case-by-case basis. Finally, 17% did not have a single executive with AVCoC (yet?).”

There is also a great discussion of AVCoC in the comments to Noam’s post.

Don Valentine from Sequoia Capital and Cisco’s founders, Len Bosack and Sandy Lerner, discuss Len and Sandy’s termination in this rare video: (Update: Google took the video down. Thank you universe. There are still some choice quotes below. If anyone has a copy of the video online or a transcript, please email us at nandn@venturehacks.com.)

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We don’t know the actual facts of the matter and we don’t care who is “right”. The lesson here is that, right or wrong, you don’t want to look back and feel the way Len and Sandy do (except for the many millions they made).

There is no such thing as a “bad” deal as long as you understand the deal’s pros, cons, and possible outcomes. But Len and Sandy, by their own admission, did not. We’ll discuss how to avoid Len and Sandy’s fate in an upcoming hack. Knowledge is power.

Some interesting quotes from the video:

“Len and I were not [savvy].” – Sandy Lerner video→

“I would strongly advise anybody watching this program not to do [what we did]… get your own [personal] lawyer.” – Sandy Lerner

“One day… seven vice-presidents of Cisco Systems showed up in my office… the outcome of which was a very simple alternative: either I relented and allowed the president to fire Sandy Lerner or they, all seven, would quit.” – Don Valentine

“[Sandy and Len] urgently sold their shares in Cisco at a time when the valuation of the company was a mere $1B.” – Don Valentine

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As usual, there were many mind-expanding comments this week—here are some of the very best.

The very lucky winner of this week’s mug for great contributions in the field of venture hacking is indicated with a subtle ball of fire.

Vesting

“Anonymous” discusses his experience with getting vested for time served and how his investors “poked out” two of the company’s co-founders:

“In my first institutional round we successfully got founder vesting put in… with a year’s worth of credit and a monthly vesting rather than an annual cliff. The company was at about 16 months old. At the time, we thought we were losers and just got ripped off but in hindsight that was a genius move. When the lead VC moved to poke out two of our 3 co-founders, that vesting took away some of the sting. Having the [credit] makes them think twice about having to spend the cash to move you out. In the end, we ended up with about 12% of the company fully diluted per founder. That’s pretty damn good, especially when we were at a $650M valuation when we got poked out.

If you are EBITDA negative, you need to expect to see [vesting] in the deal. I would highly encourage you to try and fight for the value you’ve created as much as possible and look down the road at ways in which you can preserve as much of that value as possible. If you are close to break even or EBITDA positive, this should be a non-issue.”

Yokum Taku, a lawyer, mentions that co-founders can negotiate their vesting agreements before they raise financing—this provides extra leverage in the Series A negotiation:

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“Negotiation microhack on vesting:

When the company is newly incorporated and founders shares are being issued (well before the VC Series A financing), consider hard-wiring some of the suggestions (vesting for time served, various acceleration provisions, etc.) into the Founders Restricted Stock Purchase Agreements.

Obviously, all of the provisions of the Founders Restricted Stock Purchase Agreements can (and will be) superceded by the Series A documents, but there’s a possibility that if you lead with something that is not outrageous in terms of vesting and acceleration, it might survive the Series A financing.

One ploy involves a response to the VCs along the lines of “Well – those vesting (and lack of acceleration) provisions are different from what the [fill in number greater than two] founders originally agreed upon. It took us several screaming matches to agree on upon these terms when we issued founders stock and there was a certain level of distrust during these arguments. I don’t know if I have the stomach to go back to [fill in name of potentially unstable founder least savvy about VC terms] to explain why we want to change what we agreed upon. He doesn’t really want to take your money in the first place, and it’ll push him over the edge. He/she’ll think that I’m trying to screw him/her over and may blow up the deal.

Typical legal disclaimers apply to this comment.”

Convertible Debt

“ds” says that high valuation seed financings can cause problems:

“I like [convertible debt] for the reason that it preserves upside for the angels that are taking the first layer of risk. I have seen a fair number of deals where price-insensitive angels put some $ into a company on a fairly high valuation.

Later, in the first institutional round, the VC takes a clinical look at the business and puts a different (lower) valuation on it. In that case, no one is happy…the entrepreneur feels he has done a lot of work and is moving backwards, the angel feels like he has taken risk and gotten stuffed, and the VC feels (to the extent that they feel) like they are dealing with unsophisticated operators.

[Convertible debt] is a neat structure to avoid this problem.”

Yokum Taku, a lawyer, considers whether convertible debt goes in the pre-money or post-money:

“One corollary to the Option Pool Shuffle is “What’s in the fully-diluted shares outstanding if you have convertible notes or warrants outstanding?” The issue is whether shares issuable upon conversion of a convertible bridge note or warrants issued in connection with the bridge should be considered part of the pre-money fully-diluted shares outstanding in calculating price per share of the Series A. Remember, more fully-diluted shares outstanding drives the Series A price per share down, resulting in more dilution to the founders.

Given that many companies are doing convertible note bridge financings as their seed round, this seems to come up relatively often.

VCs will take the position that all of the shares issuable upon the conversion of the bridge note and any warrants granted will be part of the denominator for calculating the price per share of the Series A.

At first glance, it seems like there is a good argument on behalf of the company that the shares issuable upon the bridge note are no different from shares issued in the Series A, and should not be included in the pre-money fully-diluted shares outstanding. In addition, warrants issued in connection with the note typically have an exercise price equal to the Series A price, so these warrants are not dilutive like cheap founders common shares.

The response from the VC is (1) the money from the bridge is gone and the value created by that money is reflected in the pre-money valuation, so the shares issuable upon conversion of the bridge count against fully-diluted shares, (2) in any event, there is a conversion discount on the note conversion so these shares are dilutive to the Series A, and (3) even though the warrants aren’t dilutive today with an exercise price at the Series A price, they will be dilutive in the future in the next round of financing, so the pre-Series A investors should bear that dilution.

Of course, with respect to (1), if there is still money in the bank at the time of Series A, perhaps some portion of the shares issuable upon conversion of the bridge should be taken out of the pre-money fully-diluted share number to the extent of the money left in the bank.

And with respect to (2), perhaps the discount portion of the conversion shares should be included in the pre-money fully-diluted share number, but the rest (to the extent there is money left in the bank) should not.

Finally, with respect to (3), perhaps the warrant overhang is not too different from multiple closings on a Series A round, where the price is set at the first closing, and second closings seem to go on for long periods of time after the first closing at the same price per share as the first closing.

I’d be curious in the VC reaction to this, because the last time I tried this, I lost arguments (1) and (2) (with not too much more logic than “no, those shares are in the denominator” – end of argument) and item (3) warrants was not applicable…

Typical disclaimers about legal advice apply to this comment.

Aside from the swipe about startup company lawyers not negotiating hard against the VCs (which I vehemently disagree with as a WSGR partner), I think you’ve done a great job educating entrepreneurs about subtle nuances in negotiations with VCs.”

Don’t let us stop you from subscribing to our comments RSS feed.

Our previous vesting hacks have discussed getting vested for time served, acceleration upon termination, and acceleration upon a sale. This article is a collection of four vesting microhacks you can use to supersize your vesting.

1. Reclaim a terminated co-founder’s unvested shares.

A terminated co-founder’s unvested shares are typically cancelled. The resulting reverse dilution benefits the founders, employees, and investors ratably.

Instead of canceling the shares, divide them among the remaining co-founders and employees ratably. You should argue that,

“Cancelling a terminated co-founders shares puts a lot of pre-money into the investor’s pocket. Those shares should be distributed among the founders and employees who created that pre-money valuation.”

This argument will carry more water if you offer to put a portion of the reclaimed shares into the option pool to hire a replacement for the co-founder.

Reclaiming a terminated co-founder’s shares does not create an incentive for co-founders to terminate each other. Co-founders have an incentive to terminate each other even if the shares are cancelled. In our experience, this incentive is never a factor. Founders are almost always allowed to vest in peace unless they are incompetent, actively harmful, or clash with a new CEO.

2. Run screaming from the right to purchase vested stock.

Some option plans provide the company the right to repurchase your vested stock upon your departure. The purchase price is ‘fair market value’. Guess whether the definition of fair market value is favorable to you or the company…

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Founders and employees should not agree to this provision under any circumstances. Read your option plan carefully.

(Props to Suzie Dingwall Williams who already brought up this microhack in the comments.)

3. Accelerate your vesting upon hiring a new CEO.

If you are having trouble applying any of the other vesting hacks, trade those chips in for six months of acceleration upon hiring a new CEO. Investors are usually eager to bring in “professional” management. They should agree to this term because it aligns your interests with theirs.

4. Keep vesting as a consultant or board member.

If you have a lot of leverage, you may be able to negotiate an agreement to keep vesting if you are terminated but retained as a consultant or a board member. For example, the company may terminate you but keep you as a consultant to help decipher your spaghetti code.

Some companies have been known to sneak this term into their closing documents. We’re not big fans of that approach.

Again, if you are having trouble applying any of the other vesting hacks, you may be able to trade those chips in for this one.

What are your vesting micro-hacks?

Submit your vesting micro-hack experiences and questions in the comments. We’ll discuss the most interesting ones in a future article.

We love the quality of the comments on Venture Hacks. You’re missing out if you’re not reading them.

A lot of the comments contain great anecdotes from founders. Others contain good questions which we make sure to answer.

Here’s a few recent ones that are especially good. You can also subscribe to our comments RSS feed.

Legal Fees

Joe Greenstein (from Flixster) says:

“I just want to throw in that my personal pet peeve with regard to the “standard” term sheet is the bit about the company paying the VC legal costs. C’mon – you have $500M and I am raising $1.5M and you want me to take the first $25k to pay your legal expenses for doing the deal? That’s like your dad giving you your allowance and then asking you to buy him a hot dog.

When we were raising money for flixster i thought that must be a trick — like if i agreed to that term they would pull the term sheet at the last second and say i failed the secret fiscal responsibility test…”

Option Pools

Andrew Parker (an Analyst at Union Square Ventures) says:

“In a negotiation, you can also try to change the rules of the game (change the formulas). For example, I know a few CEOs that have successfully negotiated that any option pool be created after the investment by institutional money, not before. So, the investors took the pool dilution along with the founders. This represents a significant increase in valuation without asking for an increase in valuation. It’s a hard chip to win in bargaining, but it’s worth taking a shot considering the high reward.”

Negotiation

“Anonymous” says:

“Some part of the term-sheets is like negotiating “pre nups”. You are basically negotiating the framework to follow when things go wrong or you end up in disagreement in future, just at the point where you are agreeing to work together in present.

One thing the article should expand upon is how to negotiate without scaring of the VCs. An entrepreneur has to balance protecting his interest with not coming across as someone that might be a “problem founder”. No VCs like to work with someone they perceive as a problematic founders. It is a tight rope walk!”

Vesting

Suzie Dingwall Williams (a lawyer) says :

“Whatever you do, make sure that the [double] trigger runs for a period of time BEFORE as well as AFTER change of control. You want to avoid any pre-emptive house cleaning of management before the deal is done.

I still get a good deal of moral outrage from investors when I try to negotiate this provision into the deal. Their objections seem to be a knee jerk reaction to anything that might cut into their ROI on a liquidty event. As if.”

“Entrepreneur” says:

“I would like to add it is possible to raise VC money without founder vesting provisions. I recently closed a series A round for a six month old company with no founder vesting provisions. We took them out of the term sheet and they weren’t discussed again. We’ve worked previously with the same VC with great outcomes so we had a strong hand.”

“A Founder” says :

“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.”

You can now subscribe to our comments RSS feed.

“We talked to a lot of different angel investors and venture capitalists, but no one really ‘got’ what we were doing — that is until we met Google.”

Dennis Crowley, Founder of Dodgeball, May 2005

“It’s no real secret that Google wasn’t supporting dodgeball the way we expected. The whole experience was incredibly frustrating for us — especially as we couldn’t convince them that dodgeball was worth engineering resources, leaving us to watch as other startups got to innovate in the mobile + social space… It was a tough decision to walk away…”

Dennis Crowley, Founder of Dodgeball, April 2007

Summary: Negotiate some acceleration if you sell the company ahead of schedule — you don’t want to stay at the acquirer for an unreasonable period of time. Also negotiate 100% acceleration if the acquirer terminates you and deprives you of the ability to vest your stock.

Your vesting should accelerate upon a change in control of the company, such as a sale of the business.

Negotiate both single and double trigger acceleration.

Your options for acceleration upon a change in control, from best to worst, include

  1. Single trigger acceleration which means 25% to 100% of your unvested stock vests immediately upon a change in control. Single trigger acceleration does not reduce the length of your vesting period. It only increases your vested shares (and decreases your unvested shares by the same amount).
  2. Double trigger acceleration which means 25% to 100% of your unvested stock vests immediately if you are fired by the acquirer (termination without cause) or you quit because the acquirer wants you to move to Afghanistan (resignation for good reason). The hack for acceleration upon termination already provides double trigger acceleration and provides sample definitions of termination without cause and resignation for good reason.
  3. Zero acceleration which is a little better than getting shot in the head by the Terminator:

The most common acceleration agreement these days combines 25% – 50% single trigger acceleration with 50% – 100% double trigger acceleration. The median of this range is probably 50% single trigger combined with 100% double trigger.

Justifying single trigger acceleration.

You can justify single trigger acceleration by arguing that,

“We didn’t start this company so we could work at BigCo X for two or three years. We’re entrepreneurs, not employees. We’re willing to work at BigCo, but not for that long.

If we sell the company after two years, that just means we did what we were supposed to do, but we did it faster than we were supposed to. The investors will be rewarded for an early sale by receiving their profits earlier than they expected. We shouldn’t be penalized for an early sale by having to work at BigCo for years to earn our unvested shares.

Single trigger acceleration reduces the effective time we have to work at BigCo and rewards us for creating profit for the investors ahead of schedule.”

Justifying double trigger acceleration.

You can justify 100% double trigger acceleration by arguing that,

“The aim of vesting is to make me stick around and create value — not to put me in a situation where I am deprived of the opportunity to vest because I am terminated for reasons beyond my control or I resign because the environment is intolerable.

So, if I am terminated with no cause by the acquirer, I should vest all my stock. Or if the conditions at the acquirer are intolerable and I resign for good reason, I should vest all my stock.”

The risk of termination at an acquirer is much greater than the risk of termination in a startup. Investors are generally investing in the future value of a startup — they’re investing in people. Acquirers are generally investing in the existing value in a startup — they’re investing in assets.

Acceleration agreements give you leverage upon a sale.

When you sell a company, the acquirer, founders, management, and investors will renegotiate the distribution of the chips on the table. It isn’t unusual to renegotiate existing agreements whenever one party has a lot of leverage over the others. To quote the fictional Al Swearengen,

“Bidding’s open always on everyone.”

Negotiating your acceleration agreement now gives you leverage in this upcoming multi-way negotiation.

If an acquirer doesn’t like your acceleration agreement, they can decrease the purchase price and use the savings to retain you with golden handcuffs. A lower purchase price means less money for your investors. This provides you with negative leverage against your investors — you can decrease your investor’s profit if you refuse to renegotiate your acceleration.

Or, the acquirer can increase the purchase price in return for reducing your acceleration. A higher purchase price means more money for your investors. This provides you with positive leverage against your investors — you can increase your investor’s profit if you agree to renegotiate your acceleration.

Visible contributors benefit the most from the renegotiation.

After this renegotiation, the CEO and key members of the management team often end up with better acceleration agreements than everybody else. That’s not a big surprise — the CEO is leading the renegotiation.

Founders who are perceived as major contributors by the board and acquirer may also benefit from the negotiation. If you’re the Director of Engineering, you’re probably invisible to the acquirer — if you’re the VP of Engineering and involved in the negotiations, you may do much better.

As always, the best defense against these shenanigans is to create a board that reflects the ownership of the company and to make a new board seat for a new CEO.

What are your experiences with vesting upon a change in control?

Submit your experiences and questions regarding vesting upon a sale in the comments. We’ll discuss the most interesting ones in a future article.

Appendix: Definition of ‘Change in Control’

A sale of the company is an example of a change in control. Your lawyers will help you define change in control. A definition that we have used in one term sheet follows.

    “Change in control” shall mean the occurrence of a sale of all or substantially all of the Company’s assets or a merger or consolidation of the Company with any other company where the stockholders of the Company do not own a majority of the outstanding stock of the surviving or resulting corporation; provided that a merger, the sole purpose of which is to reincorporate the Company, shall not be treated as a change in control.

“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.’”

Mark Fletcher, Founders at Work

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.

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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:

  1. 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;
  2. dishonest or fraudulent conduct, a deliberate attempt to do an injury to the Company or the conviction of a felony; or
  3. breach of the Proprietary Information and Inventions Assignment Agreement entered into with the Company.
    “Good Reason” shall be deemed to occur if:

    1. 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),
    2. 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
    3. employee refuses to relocate to a facility or location more than sixty (60) miles from such employee’s principal work site; and
  1. within the one (1) year period immediately following such event the employee elects to terminate voluntarily his employment relationship with the Company.

“By the time we did the financing we had been working on [the company for] 2 years, but they only vested us a year. So, they got a year of free vesting from us.”

Joe Kraus, Founders at Work

Summary: Don’t agree to vest all of your shares just because it is supposedly “standard”. Get vested for time served building the business.

Your Series A investors will ask you to give all your founder’s shares back to the company and earn your shares back over four years. This is called vesting — see Brad Feld’s article on vesting if you need a primer.

Vesting is a good idea:

You are critical to the company and you have told your investors that you are committed to the business. They are simply asking you to put your shares where your mouth is: a vesting schedule demonstrates your commitment to the company.

Vesting also ensures that a co-founder who leaves the company early doesn’t receive the same amount of equity as co-founders who stay in the business.

Get vested for time served building the business.

But don’t agree to vest all of your shares just because it is supposedly “standard”.

timeserved.png

If you have been working on the company full-time for one year, 25% of your shares should be vested up-front and the balance of your shares should vest over three to four years. The best vesting agreement we have seen for a founder in a Series A is 25% of shares vested up-front with the balance vesting over three years.

You should argue that,

“New employees who join the company today will earn all their shares over four years. Employees who are already here should be credited for their time served.”

We don’t recommend trying to escape a four-year commitment to the company (including time served). Four years is the typical commitment for a start up, high school, or college, as well as the span between Olympics and World Cups, and the term we give our Presidents to start as many wars as possible.

Consider cliffs for newfound co-founders.

One-year cliffs are typical for employees but are currently rare for founders.

Nevertheless, consider negotiating one-year cliffs with newfound co-founders whom you haven’t worked with in the past. If a co-founder leaves the company after three months, you don’t want him walking out the door with a large chunk of the company.

What are your experiences with vesting for time served?

Submit your experiences and questions on vesting for time served in the comments. We’ll discuss the most interesting ones in a future article.

Note: Thanks go to Mark Fletcher for reviewing this article and to Om Malik for co-publishing it on FoundRead.