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(Editor’s note: “Ask the Attorney” is a new VentureBeat feature allowing start-up owners to get answers to their legal questions. Submit yours in the comments below and look for answers in the coming weeks. Author Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a boutique corporate law firm specializing in the representation of entrepreneurs.)
Question: My two friends and I are launching a new venture, and we have agreed to split the stock ownership equally. The problem is that I’m not sure how committed they both are. What happens if one of them leaves in a few months? Does he still get to keep all of his stock?
Answer: That’s a good question – and a common issue among founders. I strongly suggest that you create what’s called a “vesting schedule” upon the company’s incorporation, which would require stock ownership to vest over time. It’s customary to impose reasonable vesting restrictions on founders’ stock because it has generally been issued not only for the founders’ services and/or property (e.g., software) relating to the conception of the venture, but also for their continuing commitment and efforts.
As your question implies, it would be inherently unfair for one of the founders to quit the venture after a few months (or weeks), but still be permitted to keep all of his or her stock.
The most common founder schedule vests an equal percentage of stock (25 percent) every year for four years on a monthly basis. Sometimes, however, it may be appropriate to impose a one-year “cliff” (i.e., the founders would not get their first 25 percent unless they have remained with the company for 12 months) – particularly where the founders don’t know each other or don’t have a history of working together.
Another possibility is to vest a portion of the stock “up front” (i.e., one or more founders would receive a certain percentage immediately) – usually as a result of their contributions to the venture prior to the issuance of the stock or date of incorporation. Vesting restrictions are addressed in a restricted stock purchase agreement, which each founder would be required to sign and which would grant the company the right to repurchase any unvested shares (at the initial purchase price) at the time of the founder’s departure.
In addition, investors in connection with the first professional (“Series A”) round of financing will usually require a vesting schedule. Accordingly, it would be prudent for the founders to impose a reasonable one of these upon incorporation for a second reason: If a reasonable schedule has already been established prior to negotiations with the investors, it’s more likely the investors will simply keep it in place.
If the founders haven’t established a vesting schedule or a large percentage of the founders’ stock has already vested (due to either the lapse of time or the unreasonableness of the schedule), the investors will impose their own vesting schedule –in effect forcing the founders to “earn” stock they think they already own.
This may be a difficult pill for the founders to swallow, but from the investors’ perspective, this is a significant issue – i.e., they believe they are paying for the founders’ long-term commitment and “sweat” – and thus one that they will rarely give-up.
Finally, there are often issues relating to the acceleration of vesting that need to be addressed among the founders, including (1) what happens if the company is sold and (2) what happens if a founder is terminated “without cause.”
Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. The author and his firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.
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