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Vesting is a crucial concept for startup founders, especially when you want to incentivise your co-founders. By understanding vesting and its legal implications, you can implement an effective vesting schedule that helps to ensure long-term stability in your startup. This article will explain vesting in the startup context and highlight several legal considerations related to this common practice.
What is Vesting?
Vesting refers to the process by which an individual gains full ownership of certain assets, typically company shares or stock options, over a specified period. In the context of startups, founders often use vesting schedules to align the interests of co-founders with the company’s long-term success.
For instance, imagine you co-founded a tech startup, agreeing on a four-year vesting schedule. A year after starting the business, your co-founder significantly underperforms and decides to leave the company early. Due to the vesting schedule, the departing co-founder only keeps 25% of his allocated shares, preventing him from owning a significant stake when he will not contribute to the startup long-term. The vesting schedule ensures that most shares remain with you, the more dedicated co-founder.
Defining Key Terms
The following table defines terms commonly used in discussions about vesting.
| Term | Definition |
| Vest | When you ‘vest’ a share or option, you gain full ownership of it. |
| Vesting schedule | A vesting schedule is a timeline that outlines how and when shares or options will vest. A typical vesting schedule might grant a co-founder a certain percentage of shares each year over a specific period. |
| Cliff | Sometimes, vesting schedules include a ‘cliff’. A cliff is an initial minimum period during which no shares or options vest. Often, vesting schedules look like a one-year cliff followed by a four-year vesting period. This cliff means that the individual must remain with the company for at least a year before any shares or options are vested. After the cliff, the remaining shares or options vest gradually, as per the vesting schedule, over the following years. |
| Reverse vesting schedule | A reverse vesting schedule means an individual receives their shares upfront but will forfeit them if they leave the company before a specific time. They own the shares but fully ‘earn’ them over time. A reverse vesting schedule encourages long-term commitment as the individual risks losing unvested shares if they depart prematurely. |
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Legal Considerations With Vesting Schedules
1. Drafting a Vesting Agreement
A vesting agreement outlines the terms and conditions under which shares or options will vest. This agreement should clearly outline aspects such as:
- the vesting schedule;
- the cliff period; and
- the rate at which shares will vest.
You should also detail what will happen if the individual leaves the company before they are fully vested.
2. Accelerated Vesting
Some companies include accelerated vesting provisions. These allow for the immediate vesting of all or a portion of unvested shares upon certain events, such as the company’s sale. Including accelerated vesting provisions in your vesting agreement can make your startup more attractive to potential investors, providing a clear path to ownership in the event of a significant event.
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3. Changes in the Vesting Schedule
Some circumstances may require changes to the vesting schedule, such as extending or shortening the vesting period. You should document any amendments to the vesting agreement in writing and ensure all parties agree. Careful documentation can reduce the risk of legal disputes and provide protection should a dispute arise.
4. Seeking Legal Advice
Seeking legal advice when drafting a vesting agreement can be crucial. A startup lawyer can help ensure that your agreement is comprehensive and tailored to your startup’s specific needs. They can also guide you on potential risks and best practices, reducing the risk of future legal disputes.
Key Takeaways
Vesting can be an effective way to align co-founders’ interests with the startup’s long-term goals. Understanding vesting and carefully drafting vesting agreements can protect your company and incentivise key team members.
When drafting a vesting agreement, there are several legal considerations you should keep in mind, including the following:
- drafting a robust vesting agreement, and if you choose to include accelerated vesting provisions, ensure these are clear;
- documenting any changes to the vesting schedule, ensuring all parties agree on those changes; and
- seeking legal advice to guide you through the process and ensure you draft a robust agreement.
If you want legal advice about vesting and your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Vesting refers to the process by which an individual gains full ownership of certain assets, typically company shares or stock options, over a specified period.
In startups, founders often use vesting schedules to align the interests of co-founders with the company’s success. A vesting agreement promotes long-term commitment and protects the company from the impact of early departures.
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