Thoughts on Founder Vesting
Will Blackbird take your vested shares?
Much has been written about founder vesting by Brad Feld, Chris Dixon and others, but surprisingly few have touched on the topic of whether, and in what circumstances, it is reasonable to give the Company a buy-back right to a founder’s vested shares, and if so, at what price.
At Blackbird Ventures, we agree that the first and overarching principle should be that your vested shares are shares you’ve earned, and they ought not to be able to be taken from you.
However, we think there are at least two situations in which it might be justified and even in the interest of the Company (as opposed to an individual founder) to make an exception.
Resetting of Vesting
When the company is still very early stage (say, within first 12–18 months of its life) and raising a pre-seed or seed round, we think it’s reasonable for founders to re-set their vesting at 0% and be subject to a 1 year cliff. This is because the commitment of the founders at this stage is absolutely critical to the success of the Company and if they are already 25% vested, it is that much easier to pull the jump cord when things get tough.
You need founders to be fully incentivised to stay for the long-haul, as it takes many more than 4 years to build a big successful company. You also need to arm the remaining founder/s with enough equity to incentivise another founder to come on board if the original one leaves, and in the first couple of years of a start-ups life, that can’t be a token amount. Founders of course say to their investors that they are fully committed to their start-up, and all this term asks is for the founder to codify their intent, or put their money where their mouth is.
However, this rule could result in a great deal of unfairness in circumstances where the Founder leaves due to some misfortune such as illness, injury or death before the one year cliff. This category of leaver is a so-called “Good Leaver”. In this case they ought to retain the equity as compensation for the effort they’ve expended up until that point.
The other scenario I should mention is an acquisition of the company, in which case Founders should wholly participate in the value they’ve created and have accelerated vesting if as part of the transaction they agree to leave the business. If they are staying in the business it’s likely that the new shareholders may want to keep the founder incentivised.
The second category in which it could be justified to have a mechanism to claw-back the vested equity of a founder is when a Founder does something seriously bad. Like, criminally bad or to get all legal, “nefarious”. This is known as a “Bad Leaver” and in our view the definition should be strictly limited to a narrow set of behaviours being a situation where a founder is fired for committing:
a) Fraud; b) An indictable criminal offence — ie serious crimes like murder, rape, armed robbery etc; or c) Breaching a restrictive covenant — eg stealing/breaching Company IP, starting a company in competition with the company, soliciting employees to leave the company etc.
These are seriously bad things for a Founder to do and we think that it is very reasonable for the Company to want to buy-back that Founder’s equity to:
a) Discourage (in case extra disincentive was needed!) conduct of this kind; and b) Enable the remaining Founder/s to have enough equity to offer another incoming Founder.
Pricing the Vested Equity of Bad Leavers
The most difficult question is what price ought to be paid by the Company when buying back the vested shares of a Bad Leaver (as defined above). It seems to be hard to find many concurring views on what is reasonable (or many views at all). If you accept that the circumstances in which vested equity can be bought back are basically dishonesty or criminality, how much does the Founder deserve to be compensated?
100% of the fair market value?
50% of the fair market value?
After asking around, it seems that 50% of fair market value is the market standard, with a provision that permits the Board to pay 100% of fair market value if it unanimously determines (noting that the infringing Founder is automatically removed from the Board upon dismissal and therefore does not participate in the vote). To us, 50% of fair market value feels arbitrary but better than $0 or 100%.
To be clear, all of these scenarios (Good Leaver, Bad Leaver, Accelerated Vesting on Acquisition) are edge cases but it is often the most frequently and hotly contested areas when negotiated a term sheet and seed stage legal docs with Founders. Therefore, we thought it was worth exploring as I have done here.
I should also stress resetting of vesting may also be demanded by new investors in later rounds, particularly if from Silicon Valley.
I’d love to hear what others think, and what you have been seeing lately in the market. Feel free to hit me up on email@example.com.
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