Nivi · April 19th, 2007
“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.”
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”.
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.
What do you do in a scenario where the business you’re building is 4 1/2 years old? And you haven’t raised any capital to date. And you’ve grown to $7M in 2006 rev with more growth coming, but you want to raise strategic growth capital. My guess is no way you don’t do some back vesting of founder equity, but how should you approach the situation? Thx!
Jeremy,
Clearly, our advice, which is geared more towards younger companies, doesn’t really apply. In your situation the range is anywhere from 2-years of vesting to no vesting whatsoever, depending on the maturity of your business and your leverage.
Jeremy, You might want to think less about vesting and more about putting some money in your pocket with the financing.
Ah, I see venture hacks isn’t really on the side of the entrepreneur after all.
Any VC that asks you to vest your shares is a VC who is trying to steal from you.
The business pre-money valuation is value you created. Your ownership of that is property you have EARNED.
When you take VC money, they get a percentage of the company, and your ownership is diluted, but at the same time the value of the company goes up, as it now has more cash assets in the bank. The end result is immediately post money the value of your shares should be about the same as pre-money, only the ownership percentage of the company is less.
This is fair, and this is the consideration you give up in exchange for their investment.
However, if they ask you to also re-vest your shares, are asking you to give up you property (and your voting power) in the hope that you will “Earn them back”… which first assumes you hav eto earn them (eg: it is a losss of property if you don’t own it anymore) and secondly assumes that they won’t have pushed you out. While your shares are vesting you can’t vote them, which gives the VC even more power.
Finally, they are not giving you consideration for these shares you’re putting in jeapardy and so they are simply asking you to give them something for nothing. The investment they are making is already paid for by you in the dilution you are experiencing.
There is absolutely no reason for a founders shares to re-vest.
If your ownership in the company is not enough to ensure your interests are aligned with the VCs (Who really can’t do much to make the company do well, but you can.) then the VCs wouldn’t be investing– period. So the alignment of ownership excuse is patently absurd.
No reputable VC will ask you to vest your shares. Only a thief would do that– you own the shares, and asking you to give them up for nothing is trying to take advantage.
If a VC wants to put you on a vesting schedule to keep you incentivized…. let him offer you shares out of his pool to vest into.
Anything else is exceedingly greedy on the part of the VC.
Vulture Capitalist,
Some of your theory may be right, but is pretty unrealistic. For early stage startups, VCs can’t pull their money out, and founders can’t quickly walk away with all their shares vested, so some re-vesting is inevitable and even fair.
Also note that most founders buy their shares up front and the company has a repurchase right which expires as they vest. Unlike options, this means that founders get to vote all of their shares, vested or unvested, until they leave and the unvested portion is repurchased.
In no way is “re-vesting” fair. IF you want to incentivize someone, then give them new shares to vest. That might be fair.
But “re-vesting” shares is simply having them work to earn shares whose value they have already created.
The VC invested at a given share price for a given slice of the company— the VC bought their cut of the company, and diluted the founder. Thus the VC has already been paid, and the founder has already paid — via dillution– for the added value of the investment.
“re-vesting” is just ripping people off. The math is unequivocal.
Vulture Capitalist,
You have some good ideas and some factual errors. I like your concept of “consideration for putting shares in jeopardy.”
Pre-money valuations are usually presented on a fully-diluted-basis. That means the pre-money includes all existing options and shares as if they are fully vested. (An earlier hack addressed the inclusion of a new option in the pre-money valuation.)
Like Naval said, vesting agreements for a founder are typically structured as the lapsing of the company’s right to purchase those shares from the founder. The founder technically continues to own the shares even though they are vesting. That means the founder can vote those shares even if they are not vested. (By the way, shares that have been exercised but are unvested can also be voted. For example, some option agreements allow employees to exercise their shares before they are vested due for various tax benefits.)
Your statement that “No reputable VC will ask you to vest you shares” is wrong. Every reputable and unreputable VC will ask you to vest your shares. It will almost certainly be a deal-breaker for them if you refuse.
I’ll tell you that I agree with Vulture Capitalist in spirit but it’s highly likely that you’ll lose in negotiations if you try to take this out. I like the idea of using this spirit in negotiations. I wouldn’t do it any other way now.
In my first institutional round we successfully got founder vesting put in (repurchase rights), 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 repurchase rights 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 this 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.
If I was Jeremy, I’d look more for a recap of the company to take some value off of the table before I’d consider bringing in someone to dilute me and ask for revesting.
Great article. 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.
I’d be interested in future posts about vesting requirements in a Series B. For example, if I raise a large Series B in January 2008 with 2-3 VC’s, are they likely to insist on vesting terms for the founders? The company will be less than two years old at that point.
Entrepreneur,
Vesting is a good thing for multiple co-founders. You never know when a co-founder might need to walk out the door for reasons beyond his control. I’m probably not telling you anything you don’t already know.
I can’t imagine that your Series B investors won’t ask for vesting terms.
How about during Series A vesting beyond your cliff then being told by the Series B investors that you have to revest these earned options?
This was the first time I experienced something so egregious.
To consider the broader picture of founder (reverse) vesting, you also need to consider when and under what circumstances your vested shares can be bought back. VCs will often add in provisions that entitle them to repurchase your shares if you leave the company for any reason, if you breach any covenants you have made as a shareholder under the shareholder agreement, etc. – these can work to take out your equity position in future, if not carefully drafted for your benefit.
With a vesting clause, isn’t it better for entrepreneurs be full acceleration for founders on a merger or sale? After all they did do their bit in getting it sold, and deserve their reward.
You could argue that the acquirers will find this a problem, but they could add a retention bonus. That will usually reduce the share price on exit since it comes off the top, and that reduces VC share price (all from Feld’s blog).
But isn’t this a better way (retention bonus rather than partial or no acceleration) to compensate founders for the risk taken? After all, the VC gets paid immediately…
Great insights.
How about if you are not a founder, but an “old timer” at a company.
When I started 5 years ago, they gave me options. The company went through N number of financings , the options were reverse-split 10 to 1, and then some. So now they are pretty much worthless.
The company is an very good shape right now, and there is yet another “strategic” round of financing going on after which we are supposedly going to get a new option plan.
I am just curious – is there a way for us, “old timers”, to get them all vested (or at leat 2-3 years) for the time “served”?
Or what are our other options as far as getting a fair share?
It would be great if you shared some of your thoughts in articles geared towards employees of start-ups.
Regards.
First thing you need to figure out is what is the share price currently and after the strategic round. That will tell you how much your current vested and unvested options are worth. Percent ownership is only one view… share price is usually more useful.
If you are fully vested and/or your current options are not worth much, and you have leverage, you can ask the company to incent you with new options. And, as you said, it looks like you may be getting some new options anyway.
The company is unlikely to compensate you further for time served. People are only generally going to incent you for your future work. That said, the worthlessness of your existing options can be part of your discussion, the fact that you have not been compensated for your past contributions, the fact that you are not incented to make your past options worth more through continuing work since they are already so worthless.
The other thing to consider is whether everyone in the company has gone through what you have. You may be getting the same deal as everyone else; in that case it is tough to justify special treatment. But if some people are getting special deals you can justify right-sizing.
We hope to do some “Employee Hacks” in the future.
I joined an established start up company about 16 months ago. Initially on a half time unpaid basis but I have been paid a salary (way discounted on my previous earnings) since the start of this year. I have subsequently contributed £100k in two tranches at agreed strike rates in exchange for a total of 10% equity in the company. I don’t have any equity options beyond this. Would I be expected to vest my shares? Can the VC mandate it? It seems to me that I should be in the same position as another seed investor investor in the company who has also invested £100k for about 10% but who doesn’t work for the company in any capacity. We’re about to obtain about £4M in exchange for about 30% of the company so it is very relevent to me at the moment.
Supplementary questions. Brad Feld’s excellent article on vesting equates vesting to an alignment tool. Does this/can this also apply to the equity purchased by seed investors? Also, assuming I do get to keep my stock, should I expect to have a share in the option pool – vesting as appropriate – to incent me going forwards?
Thomas