You may have heard the term ‘share vesting’ bandied about by startup founders and employees, it’s more common in the US than the UK, but what’s it all about?
Share vesting is the process that allows a founder or employee to ‘earn’ their shares or stock options over time (this is common), or based on hitting certain milestones (this is less common).
For instance, let’s say John and Paul incorporate a company together, with each owning 50 shares. They could decide that both of them will be subject to vesting. The vesting schedule sets out that vesting will take place over 4 years with a 1 year ‘cliff’. This means that if either leaves the company within 1 year (the cliff period), the leaving founder will have to return all of his shares without getting paid fair value for them. After the 1 year cliff period, both will have vested 25% of their shares, and going forward will continue to vest just upwards of 2% every month, until they will have vested all of their shares after 4 years.
So what happens if John leaves after 2 years? In this intance 50% of John’s shares will have vested (i.e. 25 shares). It then depends on the vesting arrangements whether:
- John gets to keep the 25 shares, or
- whether he needs to offer them for sale to the company or Paul (in which case the company or Paul will need to pay fair value for the shares if they’d like to purchase them).
Any unvested shares will again need to be returned without payment.
Vesting provisions can protect the company and also the founders from each other. Without vesting arrangements, John could’ve simply walked away after a couple of months and kept his 50 shares. It would then have been up to Paul to try to buy the shares back from John.
If he couldn’t afford to pay John fair value for the shares, the situation might have effectively killed the company. After all, Paul would have little incentive to continue working hard knowing he’s doing all the work but will only get 50% of the benefits. Also, most investors will not want to invest in a business if 50% of the shares are held by a person who is not contributing anything!
Vesting schedules for employees work in a similar way, but are typically issued under an EMI options scheme.
It might feel like yet another cost to get vesting sorted when you’re starting a business, but the value of getting it in place is massive (even if you completely trust your co-founder). After all, there could be many reasons why a founder might quit after only a short time period. Their family situation might change, they might get an amazing job offer, or wish to move to another country. It is crucial to protect yourself and your company against a founder leaving earlier than you would both expect.
With legal matters it is often hard to judge when is the right time to get certain things sorted. However, if I had to rank which legal matters to pay for first in a company’s life, vesting provisions would score top of that list.
If your business is based in the UK and is looking for a lawyer to set up a vesting schedule, you could consider getting multiple quote from handpicked corporate lawyers via Lexoo. Many of the lawyers on our platform specialise in this type of thing and can guide you through the process.
If you are based in the US we would recommend using a similar service such as Priori Legal