Vesting and buyback rights

Why do startups need a Founder Stock Restriction Agreement?

Few events create more resentment than founders departing after a short time, but retaining all of their founder stock. These founders can be seen to get a free ride on the work of those remaining. To prevent this, startups often institute a vesting schedule where founders earn their founder stock over time. This way, the company (and sometimes other founders) has the right to buy a departed founder’s stock. Vesting and buyback rights are usually found in a Founder Stock Restriction Agreement.

How does a Founder Stock Restriction Agreement work?

In a typical vesting arrangement, the company has the right to buy back all or some of a founder’s unvested stock when the founder’s involvement with the company ends. Events that trigger buyback rights can include:

• The founder’s death
• The founder’s disability
• Resignation by the founder of his or her employment
• Termination of the founder’s employment with cause, and/or
• Termination of the founder’s employment without cause

The buyback may happen automatically, or it may be an option for the company. The purchase price is usually either the price the departing founder paid to purchase the shares (often, a nominal value like US$0.0001 per share). Sometimes a fair market value purchase price is used for no fault events, like a founder dying or becoming disabled.

What is a typical vesting period for founder stock?

The vesting period for founder stock typically falls between three and five years, with a variety of formulas used for determining when shares will vest. The most common vesting schedule is a one-year cliff, meaning no shares vest until the end of one full year of service, with 25 percent of the shares vesting at the end of year one. Then an equal portion of the remaining shares vest at the end of each month or calendar quarter for the next three years. The goal in setting a vesting schedule is to choose a period that is long enough to ensure meaningful contributions from the founder, but not so long that the founder loses motivation.

While some founders are reluctant to self-impose a vesting schedule, vesting conditions frequently are in the group’s best interest when there is more than one founder. Sophisticated investors will also often require vesting conditions or repurchase agreements as a condition of their investment. Designing and adopting a vesting plan not only adds to the founders’ credibility, but also may allow the founding group to escape a harsher plan imposed by investors.

Questions? Email us at startups@dentons.com.