Continuing our analysis of the “Open Source Seed Financing Documents” released by the Australian Private Equity and Venture Capital Association Limited (AVCAL), this article looks at how founders can ensure that they retain ownership of their shares when approaching investors to raise capital.
Ownership and Vesting of Founder Shares Under the AVCAL Shareholders Agreement
Under Clause 11 of the AVCAL Shareholders Agreement:
- Half of the founders’ shares will vest over a period of four years.
- If the company employs or contracts the founder, their shares will vest as follows:
- 25% of shares after twelve months; and
- 25% after that, gradually over the next 36 months.
If the company ceases to employ or contract a founder, the company may purchase any unvested shares for just $1.
Under Clause 12 of the AVCAL Shareholders Agreement, the company may acquire the shares which the founder wholly owns (either from the outset of the agreement or which have vested over time) when certain events occur (including the founder ceasing to work for the company). The board, or an independent expert, determines the fair market value and the purchase price is set at half of this value.
When Can a Founder Lose the Full Value of Their Shares?
A founder typically foregoes a significant amount of salary when setting up a business to help grow the business and is compensated via a large shareholding (‘sweat equity’). Initially, their shareholding may be worth nothing but following the investment, it should be worth a lot more.
But what if the founder leaves the company eleven months after the investment? Consider the reasons why the founder may ultimately leave the company. It may happen that a family member becomes very ill and consequently, he or she decides to leave their role with the company to attend to their relative. Perhaps the founder herself (or himself) suffers incapacity on account of a bike accident. Alternatively, the company may terminate the founder’s employment.
If a founder leaves the company eleven months after the investment, then that founder will have to sell all of their unvested shares (i.e. 50% of their total shares) in exchange for $1. Also, the founder will have to sell back all of their vested shares (i.e. the remaining 50% of their total shares) for half of the fair market value.
Although this can seem harsh, investors are looking to incentivise the founders to stay with the company and help it grow. Further, if the founder does leave the company, they want to be able to offer a replacement worker equity in the business. It then makes sense that the departing founder relinquishes some of his equity so as to incentivise his or her replacement.
Recommendations For Founders
Investors will insist on having vesting provisions in the Shareholders Agreement, however, you could look to negotiate:
- A higher number of shares to be owned at the outset and not subject to vesting;
- A shorter period over which the shares will vest;
- The amounts payable for shares which have not vested at the time a founder leaves the company (e.g. the issue price of such shares); and
- The amount payable for shares which have vested at the time a founder leaves the company (e.g. 100% of fair market value if they are a good leaver as opposed to 80% of fair market value if they are a bad leaver).
If you have any questions or require assistance negotiating your startup documents, get in touch with our capital raising specialists on 1300 544 755.