The ins and outs of founder vesting

Series A and later-term sheets usually include founder vesting clauses (i.e., when a founder’s shares are issued up front but only unconditionally owned once they are earned over time). In this “tricky clauses” guide, we look at how vesting works and the difference between good leavers and bad leavers (and why they leave), as well as what founders should think about before they sign.

Photo credit: Kelly Sikkema

How does founder vesting work?

Founder vesting comes up in a few scenarios:

• Under an employee stock ownership plan, where an employee receives unvested options over shares in a company
• When co-founders sign vesting agreements before their company has investors (for an example, see our founder agreement template)
• In fundraising documents where investors seek new restrictions on founders

In this guide, we look at the third item above – where investors ask a founder to sign up to new vesting arrangements.

Vesting motivates founders to stick around for a period of time, usually around three to four years. Investors back startups based on the team as much as anything. Your series A term sheet is therefore very likely to have a clause such as this:

“Founders’ shares will be subject to a four-year vesting period, with a one-year cliff, with vesting being on a monthly basis thereafter.”

How much should be vested?

Should 100% of a founder’s shares be vested?

Not necessarily. If founders have been working in the business for several years, they have a good argument that most of their shares should be vested. Sometimes, founders may even have put their own cash into the business during its early years. Having paid value for those shares, it is harsh for them to lose those shares if they leave before the end of an agreed vesting period for whatever reason.

Generally on deals, we see 50% to 75% of a founder’s shares subject to vesting, rather than the full 100%. This varies a lot, however. Investors will argue that the purpose of vesting is to look forward rather than back, and that they are simply trying to retain the people who are key to justifying the valuation at which they are investing. The counter argument is that if founders have been slogging away for some time, they have earned most of the shares anyway.

How long should the founder vesting period be?

Vesting periods in Southeast Asia are typically three- or four-year periods, with four years being the most common. Following the lead from the US, we often see a chunk of shares vesting after 12 months (the cliff) with the balance over the next three years. So a typical vesting period could be 25% immediately vested, a further 25% vesting after 12 months, with the balance over the remaining three years. There is plenty of variation on this, however.

Good leavers and bad leavers

There’s generally a difference between a “good leaver” and a “bad leaver.” Typically, a founder is a good leaver when his or her employment has been terminated by the company without cause or when he or she voluntarily terminates employment with approval of the board (usually including the investor director). An example of someone being dismissed without cause might be when he or she is terminated for performance reasons, as opposed to some kind of misconduct.

Why does it matter if a founder is a good leaver or a bad leaver?

It matters because the departing founder’s shares are treated very differently. In Southeast Asia, we typically see the following:

• In a “good leaver” situation, the company can buy back 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. The departing founder typically keeps his or her vested shares.

Why it gets contentious

The takeaway on founder vesting