What is Share Vesting and Why Does it Matter to My Startup?

In Short:

• Share vesting ensures co-founders earn equity over time, typically over four years, with a one-year cliff.

• If a co-founder leaves before the cliff, they forfeit unvested shares; after the cliff, shares vest monthly.

• This arrangement protects the startup and reassures investors about the co-founders’ commitment.

Tips for Businesses:
Share vesting aligns the interests of co-founders and investors by ensuring that equity is earned over time. Implementing a clear vesting schedule, often with a one-year cliff, incentivises long-term involvement and protects against the risk of co-founders leaving prematurely. This approach can also make the startup more attractive to investors.

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Table of Contents

• What is Share Vesting?
• Why is Share Vesting Important?
• When is Share Vesting Relevant?
• Key Takeaways
• Frequently Asked Questions

Share ownership is important for both co-founders and investors. Startup co-founders typically agree to have their shares vest over a period. But how does share vesting work and what does its structure suggest to potential investors?

What is Share Vesting?

A startup can either have vested or unvested shares. A vested share is one that you can act on and sell. An unvested share is one that you can act on and sell after a period has passed, or an event occurs.

Time-Based Vesting

 A typical arrangement is that shares will vest after a period of time (usually four years). The vesting period commences after a specific period (usually one year) from when the co-founders agree (known as the ‘cliff’). Practically, a co-founder will get nothing if they leave the company before the first year has passed. Implementing a cliff can be helpful in protecting against early departures and ensuring that the co-founder or employee bound by the vesting condition has meaningful commitment. At the one-year mark, generally 25% of the shares will vest and then, from that point onwards, they vest at just over 2% per month until you reach 100% (assuming they vest monthly over a further 3 years).

You can structure your vesting period flexibly. For example, you may not require a cliff, or you may backdate to when you and your co-founder(s) first started working on the idea – even if you did not incorporate the company until later down the track.

Other Forms of Vesting

While less common than time-based arrangements, vesting can also occur when the business, or co-founder, achieves particular milestones. For example, revenue targets or particular key performance indicators.

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Why is Share Vesting Important?

Broadly speaking, share vesting has three purposes:

1. Incentivise the co-founder or employee to stay working in the business so that their shares vest;
2. Protect the business if a co-founder or employee leaves; and
3. Signals to investors the founder’s commitment to growing the startup.

If a co-founder or employee leaves, they will only receive the benefit of the shares that have vested. Otherwise, they will receive no benefit at all if they leave before reaching the vesting cliff. This arrangement can potentially cost the co-founder or employee a significant amount of money if the shares they are forfeiting are (or could be in the future) worth a substantial amount of money.

Share vesting is also beneficial for your investors. A share vesting agreement can help mitigate risk, protect your startup and demonstrate to investors that you are committed to growing the company. Founder vesting is often a key item within a term sheet and discussed with the lead investor during the early pre-seed and seed rounds.

When is Share Vesting Relevant?

Co-founder Exit

Running a startup is stressful. Juggling an often untested idea with access to limited capital in a dynamic market will often cause friction between co-founders who may have different ideas about how the company should operate. Unsurprisingly, this environment can lead to disputes – some of which may result in the relationship between co-founders breaking down.

Future Investment

Later-stage investors, such as venture capital firms, are less likely to invest in a startup if the remaining co-founders hold only a small portion of the equity. Investors view co-founders who only hold a small portion of equity as less incentivised to continue shouldering the stress of growing the business. If you secure funding, your investor may also require you to re-vest your shares.

Key Takeaways

Share vesting is a process where co-founders earn their equity over time, typically over four years with a one-year cliff. If a co-founder leaves before the cliff, they forfeit unvested shares. After the cliff, shares vest monthly. This structure ensures that co-founders remain committed to the business and reduces the risk of early departures. It also reassures investors by demonstrating the long-term commitment of the founding team, which enhances the startup’s attractiveness to potential investors. Implementing a clear share vesting schedule can help align the interests of co-founders and investors, providing greater stability for the business.

If you are drafting a share vesting agreement, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions