09.06.2022, English Articles

Founder Vesting: Necessity for Startups!

Why vesting clauses are mandatory when founding a startup

Author: Fiona Schönbohm, lawyer for startups in Hamburg and Berlin

DE/EN: This article is also available in german! / Diesen Artikel gibt es auch auf deutsch.

Most startups begin with a common idea: three friends or colleagues get together, work on the project a little at first, then more and more, and finally full-time. They found a company and get investors to finance the startup - so far, so good.

Since legal advice is not for free, many unfortunately often save at the wrong end when founding the startup at the beginning - and years later are confronted with contracts that significantly affect the successful progress of the company - such as: unfavorable majority requirements in the articles of association, missing redemption provisions or even a missing vesting. Why founders of startups should in most cases provide for vesting regulations from the very beginning, we therefore shed light on - free of charge - in this article.

What is Vesting and how does it work?

So-called vesting clauses can now be found everywhere in practice: in financing rounds, participation agreements or employee stock option programs - and often even when a company is founded. The principle of vesting always works in the same way: founders or employees of startups must "earn" their share in the company for a certain period of time by making their work available to the startup for a certain period of time (the so-called vesting period).

If they leave the startup prematurely, they lose some or all of their shares. Typically, they receive either nothing at all or only a reduced amount measured against the market value of the company as compensation for the lost shares - depending on why and when they leave. The various constellations are differentiated by so-called bad and good leaver clauses.

You can find more information on vesting on our website on the subject: Vesting clauses

Why vesting for founders?

In practice, a founder vesting is often only agreed upon at the express request of investors who join the company at a later date - these investors want to ensure that the heads of an acquired company do not jump ship with the fresh money shortly after the exit, but rather make their know-how available to the company for a certain period of time even after the investment. A founder vesting is therefore often agreed only afterwards.

In fact, however, vesting arrangements are increasingly being included directly between the founders themselves, even at the start of the venture. Background: Let's assume that all three friends from our example above each have a one-third stake. In the first few months, all three put all their effort into the project - but then founder A loses interest in the project and looks for another job. Although B and C continue to slave away alone for the project, founder A is still entitled to a third of everything. B and C rightly feel that this is unfair at some point.

Founder vesting: fair distribution according to the founders' work performance

A vesting arrangement at the time the company was founded would have ensured that A could only keep his full number of shares for as long as he made his full work available to the joint company. If he wants to leave earlier, he has to give back part of his shares and may be compensated (with a discount) according to the value of the company at the time of his departure. As a result, his previous work performance is sufficiently and fairly rewarded - but he no longer participates to the same extent in future increases in the value of the company that are achieved solely through the work of the two remaining B and C.

In addition, giving up A's shares also creates new opportunities to replace A's role and possibly bring a new shareholder on board who will perform A's tasks in the future and, in turn, can participate in the increase in value from the time he joins the company via the shares.

Implementation: Reverse vesting for founders

In practice, so-called reverse vesting is usually agreed for founder vesting. This means that the founder is not allocated shares on a monthly basis - in which case the value and taxes would be recalculated each month with each share transferred. Instead, the founder is first allocated his full shares. At the end of the vesting period, all of his shares are vested and thus secured. If, on the other hand, the founder leaves the company prematurely during the vesting period, he loses the part of his shares that is not "secured" (possibly in return for a severance payment, possibly with a discount).

It is also possible to agree a pro rata adjustment of the vesting in relation to work performance. If the founder starts full-time, but after a certain period of time does not want to leave the company completely, but only wants to reduce his working hours to 4 or 3 days a week (part-time), the vesting period will be adjusted accordingly.

We recommend: Legally sound shareholder agreement avoids disputes

To avoid delaying the process from the outset, a conditional transfer of the shares is usually agreed. If the shareholder leaves the company, the existence of the leaver event need only be established, and the non-vested shares of the departing shareholder automatically revert. In a second step, the purchase price is considered first. In this way, the company remains capable of acting and can act quickly.

In order to prevent further disputes, we recommend that an irrevocable resolution of consent of the shareholders' meeting to the transfer of the vested shares be included in the shareholders' agreement subject to a condition precedent. In this resolution, all shareholders agree to the transfer of the shares in the event of a leaver event and, as a precaution, waive all other rights under the partnership agreement, such as pre-emptive rights and tag-along rights.

If a dispute does arise between the founders at a later date, it does not paralyze the entire company - for example, because it is temporarily unclear who actually owns the company and who is entitled to make the relevant decisions. Only when a court ruling is issued do any subsequent changes have to be made, if necessary.