Everyone Should Vest

February 27, 2018  |  By Kevin Vela

One of the biggest mistakes that startups make is failing to place vesting conditions on founders’ equity.

Here’s an example: Two founders, Adam and Blake, are working on their startup, and everything is butterflies and rainbows. They have a great idea, a hot pitch deck, and lots of wishful thinking. They are looking at a spreadsheet where the profits graph shoots straight to the moon. Adam and Blake have agreed to split the equity 50/50. They are meeting nights and weekends while they hold down full-time jobs.

But now, it’s time to move past nights and weekend and go full-time. The founders need to quit their jobs and work unpaid while they really build the startup. Adam is all in. He’s ready to tap into his savings and really invest into the startup. Blake is not. Maybe Blake doesn’t have the tolerance for risk that Adam does, or maybe Blake isn’t in the same financial position as Adam is. But Blake promises the he will be able to put in just as much time as Adam does, even though Blake will only be working nights and weekends.

This is a recipe for disaster. Before long, Adam will grow frustrated, and maybe resentful, that he is working full-time for the same equity as Blake, who is still receiving a regular paycheck. Best case scenario – the guys meet and have a difficult and awkward conversation about ownership. Worst case scenario – Blake walks away with 50% of the company and leaves Adam upset and without a partner, or the equity to attract one.

Here’s a second example: Christina has a great idea for a mobile app. Her friend, David, works as a software developer for ACME Co. and says he’d love to build the app for her in exchange for 20% equity. Christina knows that the alternative is to pay $50k+ for a prototype of the app so she agrees to bring him on as a “co-founder,” and they get to work. Again, everything is butterflies and rainbows for a few weeks as they meet nights and weekends to work on the app. But a month or two into the project, David gets promoted at work and starts dating someone new. His project updates are less frequent, and he’s not checking in on their shared Slack channel every day. Christina becomes embittered and faces the reality of having to actually hire someone to finish the app, while David still owns 20% equity.

I see all kinds of situations where founders fail to appropriately vest equity, and it leads to strife and discontent. This is why everyone should vest.

If you were to get a job at Google and receive options as part of your compensation package, those options will undoubtedly vest over time (usually four or five years). This is because Google is using the options to keep you around. The equity in your startup should be treated the same – even for founders.

The typical vesting schedule for a startup is monthly, over 4 years with a 1-year cliff. This means that 1/48th of the recipient’s shares vest monthly, except that the first year has a 1 year cliff – or no vesting until day 1 of month 13, when 1/4 vests. Then the vesting is 1/48th each month for the remaining 36 months. (You can see a visualization here.) Moreover, some or all of the equity usually accelerates upon certain events (i.e. a change in control or termination without cause).

This vesting schedule is typical for founders and later employees, with the caveat that founders are usually on a “release schedule” instead of a traditional vesting schedule. I’ll explain how that works in my next post.

About the Author(s)

Kevin Vela

Kevin is the managing partner at Vela Wood. He focuses his practice in the areas of venture financing, M&A, fund representation, and gaming law.

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