What is Founder Vesting?
Founder vesting is the process by which the founders of a company are rewarded with equity in proportion to their contribution to the company.
Founder vesting works as follows:
The founders agree on a certain amount of equity that each founder will receive when the company is sold or goes public.
Each founder is given a portion of that equity based on their role in the founding team. For example, if you are the CEO, you may get 25% of the total equity and your co-founder may get 15%.
That initial percentage remains unchanged throughout your time at the company. No matter how much value you contribute, you always own that same percentage. (As an aside, it is possible to increase your percentage by raising more money.)
The catch is that your equity does not fully vest until you stay at the company for a certain period of time (typically 4 years). If you leave before then, all of your unvested shares revert back to the company. If you stay for 4 years or more, then all of your shares fully vest and belong to you forever. It’s called “cliff vesting” because there is no middle ground — either it vests or it doesn’t. There are some variants on this theme where founders can forfeit unvested shares if they violate their employment agreement, but they don’t have any bearing on our discussion here.
Why Use Founder Vesting?
Founder vesting is a great way to motivate founders to stick around for the long haul. It is an especially good idea if you are bootstrapping a company, because it can help you attract talented co-founders who might otherwise not want to give up a lucrative job at Google or Facebook.
Founder vesting also protects founders from each other. If you and your co-founder disagree about the direction of the company, it is easier for one of you to leave without completely destroying the company’s equity structure. In this case, your shares will revert back to the company instead of being split up between your co-founder and another new founder.
Finally, founder vesting prevents any one founder from leaving with a majority of the equity if they decide to start another company. This is called “single founder liquidation preference” and has led to some very bad outcomes in recent years.
For example, Mark Zuckerberg’s departure from Facebook caused him to end up with 72% of his own startup (Zuckerberg paid $300 million for Instagram), which was subsequently sold for $1 billion (allowing Zuckerberg to make a huge profit).
If Zuckerberg had been subject to founder vesting, then he would have only owned 25% of Facebook at the time he left, allowing his co-founders and investors (who had been patiently waiting for him) an opportunity to cash out some or all of their shares as well.
The good news is that most investors have now learned their lesson on this topic and are asking founders not use single founder liquidation preference in their seed financings going forward.
About the Author
I am the Founder of Cudy Technologies (www.cudy.co), a full-stack EdTech startup helping teachers and students teach and learn better. I am also a mentor and angel investor in other Startups of my other interests (Proptech, Fintech, HRtech, Ride-hailing, C2C marketplaces and SaaS). You can also find me on Cudy for early-stage Startup Founder mentorship and advice.
You can connect with me on Linkedin (https://www.linkedin.com/in/alexanderlhk) and let me know that you are a reader of my Medium posts in your invitation message.