Vesting

German lawfirm advising on vesting clauses

Vesting requirements for startups - employees, founders & investors

So-called vesting clauses are now found everywhere in practice: in financing rounds, participation agreements or employee participation programs, for founders, minority shareholders or new employees.

The regulations, which are often imported from the US legal area, are based on a comprehensible motivation of the investors - but are often illegal due to their concrete design. In German law, the clauses have to pass all kinds of tests and their validity must always be checked in the concrete individual case.

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Legal services for vesting

The attorneys, specialist lawyers and tax advisors in our firm provide comprehensive advice on the subject of vesting at our offices in Hamburg, Berlin, Munich, Frankfurt and Cologne, including the following aspects

  1. Examination of existing vesting regulations for their validity and legal consequences of any invalid clauses
  2. Support in contract negotiations on vesting clauses for founders of start-ups, employees in start-ups or investors
  3. Drafting of employee participation programs and virtual employee participation (ESOP, VESOP) and management participation
  4. Support of financing rounds and drafting of venture capital investment agreements
  5. Representation in legal disputes about the validity of existing vesting regulations

An overview of our other services for start-ups and investors can be found here: Legal advice for founders and investors

More topics for startups! Click here for an overview of our legal services for startups.

What does vesting mean?

The principle of "Vesting" works as follows: Founders or employees of start-ups must earn their stake in the company by investing their manpower in the progress of the start-up for a certain period of time.

In doing so, they save, untechnically speaking, a certain number of shares per month they work in the company. In the end, they are entitled to the shares or virtual shares in their entirety or, depending on the structure, are remunerated at market value in the event of an exit. However, if they leave the start-up prematurely, they lose part of their shares or only receive the nominal value or a reduced amount based on the market value.  

On the one hand, vesting can bind the founders of a company to the company vis-à-vis the venture capital investors when financing start-ups. On the other hand, the start-ups themselves often use the vesting model to bind their own employees to the company.

Conflicting interests of employees, founders and investors

The background to vesting is the legitimate interest of investors in binding important employees or founders of start-ups to the company whose shares they have acquired for a certain period after their investment. After all, the value of a start-up is often largely determined by the know-how of the people who run it. If these people were able to leave the company with all their remaining shares after the investment, the investors would suddenly be left empty-handed.

The same applies to founders who bequeath (virtual) shares in the company to their employees within the framework of participation programs. They also want to ensure that their employees work for the start-up for a certain minimum period of time.

The interests of those obliged by the vesting often conflict with this interest. On the one hand, the freedom of occupation under Article 12 of the Basic Law applies in Germany, which is expressed in various simple legal norms. Everyone must be free to choose his or her profession and an unacceptably long commitment to a company is illegal. Founders in particular have often already invested considerable manpower in the company and must be paid accordingly for the work they have already done.

Virtual Shares Click here for more on virtual stock options.

Good & Bad Leaver

In order to bring these conflicting interests into an appropriate balance, a differentiation in vesting must be made in each individual case. This is done in practice by means of so-called Good Leaver clauses and so-called Bad Leaver clauses. The legal consequences of the departure of the affected parties vary in severity depending on when and why the employee or founder leaves the company.

The exact arrangement in practice varies greatly. Good leavers include cases in which the person concerned leaves the company "through no fault of their own", for example if the company gives him or her proper notice without good reason, if a temporary exit occurs, if he or she falls permanently ill and therefore becomes incapable of working, or if he or she dies. As a result, he will be awarded a higher share of shares or will receive higher compensation than a bad leaver.

Bad leavers, on the other hand, are usually those cases in which the person concerned is himself to blame for extraordinary termination by the company or if he does not fulfill his contractual obligations. The person concerned then loses his or her shares or only receives reduced compensation for them.

The case of ordinary termination by the employee is particularly controversial. These cases, known as "Grey Leaver", are often classified as Good or Bad in practice or are regulated separately.

Severance payment regulations may be invalid

The cases that are common in practice are often ineffective in their design. Because the respective clause must be strictly proportional in the concrete individual case. The following factors are to be considered in the weighing:

  1. Settlement value in relation to the actual market value
  2. Reason for leaving the company
  3. Payout modalities (e.g. payout periods)
  4. Type and extent of previous participation

In practice, work already performed for the company is often not adequately taken into account, the vesting period is too long or the respective reason for leaving the company, for example due to illness, is unacceptably sanctioned as a bad leaver. Even if the classification of a case as good or bad leaver is correct, the respective legal consequences may still be inadmissible in individual cases, for example because the person concerned loses his or her shares without compensation or only at par value even after remaining with the company for years.

Special case: Founder's vesting

Especially founders of start-ups, who are obliged to vest by investors, have particularly high requirements due to the services already provided by the founders. In addition, company law contains the so-called prohibition of termination for shareholders. This means that shareholders of a company cannot be easily dismissed by other shareholders from their position as shareholders simply because they terminate existing employment relationships. This is because the shareholder position is independent of the employment relationship for the time being.

In particular, if the founder retains a majority of the company's shares, investors are therefore denied the opportunity to acquire the majority of the company's shares through the back door, so to speak, via a vesting clause.

Structuring options - consider taxes!

When structuring the vesting in contractual terms, it is also essential to consider the tax perspective and to consult a tax advisor you trust.

In order to avoid imposing a tax burden on the persons obliged by the vesting, the vesting is often structured as an irrevocable purchase right (call option): From the beginning, the employees or founders are entitled to the shares subject to the vesting, but the investors have a right of purchase over the shares to be vested at predetermined conditions, which diminishes from month to month.

What is Accelerated Vesting?

Accelerated Vesting: In the case of an early exit during the current vesting period, it is agreed that all shares of the parties concerned are considered as vested. Often, however, the founder is then obliged to work for the company for a further period.

The background to this arrangement is that the company has performed particularly well in the event of an early exit due to the performance of the employees and that they should therefore also participate in the early profit. The investors' expectations of success were then exceeded, so to speak.

Conclusion: Consult a lawyer!

As a result, it is essential to check the validity of each individual case before drawing up a contract. A blanket assessment of vesting clauses is absolutely forbidden.

Employees and founders who are already subject to vesting regulations are also well advised to have the legality of the regulations applicable to them checked by a lawyer in the event of their leaving the company. If the regulations are ineffective, they may be able to claim significantly higher severance pay or even keep their shares.

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