Ah yes, the “V” word. This is when the conversation starts getting juicy. One of the most sensitive discussions I have with co-founders as I help them navigate through the incorporation process and through their initial hiring is around vesting. It is also the place (other than IP) that entrepreneurs seem to get wrong the most. Let's look at two components of vesting which give founders (and investors) the most headache:
Time based vs Milestone based
99.9% of the time, milestone vesting fails to accomplish the incentivizing that founders had initially anticipated. Instead, the metrics, amounts, and other key components that make up the milestone vesting become stale before the ink on the restricted stock agreement has a chance to dry. This problem is particularly emphasized at the inception of the business -- how can you successfully tie vesting to predetermined milestone achievements if you haven't figured out your business model? By the time you unearth the restricted stock agreement tucked away in your email folder to check the milestone vesting provisions, the business will have pivoted 5 times. Not to mention, that is the best way to bust your deferred legal fee threshold before you even get started. For those reasons, I strongly advise against it. Instead, stop being cute and stick to what every investor would have expected in the first place -- time based vesting with a cliff, of course, to incentivize folks to stick around and hedge against the founder/employee who isn’t carrying his/her weight!
The other truly customizable feature in vesting is around acceleration. Here are the two most typical flavors to consider:
o Acceleration upon a sale of the company (ie “single trigger” acceleration):
Most likely ok at the start but typically when your first institutional investor comes in at a seed or A round, they will condition their investment on the founders and other key employees amending their stock agreements in favor of a flavor of double trigger acceleration (discussed below) as they know better than anyone else that your future acquirer isn’t going to love the idea that you walk on the closing of your company sale fully vested.
o Acceleration if you are terminated without cause within 12 months of a sale of the company (ie “double trigger” acceleration)
This is the more common permutation and the most industry accepted. Some times, executives will request that in addition to the "without cause" trigger, they get the benefit of a "good reason" trigger so if the executive were to resign for good reason within 12 months of an acquisition, they would get the benefit of acceleration. The issue with including that second trigger is that the definition of "good reason" is almost always implicated at the point of sale of the company (re: you no longer get the title of CEO of your acquirer), so the double trigger concept loses its functional bite out of the gate.
And now for the most important point of this post. Ready. Take a seat and break out the popcorn. If you are looking for a sure fire way to handcuff your start-up, flush all your hard work down the toilet, and force a dissolution, go ahead and include a third form of acceleration -- Accelerated vesting upon a termination without cause. The biggest no-no in the industry. Because of the market’s tight definition of what constitutes “cause” (basically you killing someone), you are 99.9% of the time going to be fired without cause. So what is the big deal you might ask. As a founder, doesn’t this protect me? Sure it does, but if you include this term in your agreement, then all your co-founders will get it as well. And if they get it, and it turns out one of them isn’t who you thought he/she was, you will want to fire them. And having them walk away with a material amount of their shares vested through acceleration, well, kiss your chances of raising money goodbye.
Interested in current market trends with respect to vesting for founders, advisors, consultants, employees? I'd love to chat. Oh, and, don’t forget to file those 83bs!