Stock Vesting, Cliffs, and Preventing Your Co-Founders from Jumping

Updated: Aug 13, 2019

So you incorporated your company, and you know that the one thing you must do after incorporating is issue stock to yourself and your co-founders. The obvious first step is to discuss how many shares to issue to each of the founders. There's a bit more to it than simply writing down each founder's respective shares on a napkin contract. In addition to deciding how much stock to issue to each of the founders, you’ll need to consider whether the founders’ stock will have vesting restrictions.

In the simplest terms, vesting prevents founders (or any new addition to your team) from receiving their entire share of stock up front, and then slacking off or leaving the company entirely. A small team of 3-4 founders can be left in a tough spot if one founder stops contributing to the work after receiving his or her stock grant. On the other hand, if the founders and other early team members are granted stock subject to vesting, each person will have to pull his or her own weight, or risk losing all or a portion of his or her shares.

So how does it work? When stock is issued subject to vesting, the company has an exclusive right to repurchase the stock if the stockholder leaves the company or is terminated. The company’s right to repurchase the stock only applies to unvested stock, which is where the vesting schedule and vesting cliff come in.

The vesting schedule is the period over which the stockholder’s stock is released from the company’s repurchase option. The vesting cliff dictates when a portion of the unvested shares are first released from the company’s repurchase option.

If you are granted 100 shares on a 4 year vesting schedule with a 1 year cliff, the company will no longer have the right to repurchase 25 of your shares after 1 year (the cliff). You will earn (and the company will lose its right to repurchase) the remaining 75 shares on a monthly basis over 3 years after the cliff (at a rate of roughly 2 shares per month for our example). Your shares are considered "fully vested" on the 4th anniversary of the date you purchased the shares. There are some exceptions to this, depending on whether your stock purchase agreement contains a provision for single trigger acceleration or double trigger acceleration, but acceleration clauses are for another article.

In short, vesting restrictions protect the company and the founders.

As mentioned above, there is a bit more to properly issuing stock than simply jotting down the founders' respective percentages. The terms of each stock issuance, including any vesting restrictions, must be approved by the Board of Directors. After the Board approves the stock issuance(s), usually by a written consent, the stock is issued using a stock purchase agreement that is signed by an officer of the company and the stockholder. Stock purchase agreements are fairly standard, but it's important to make sure your agreement includes all of the necessary components. If you need a stock purchase agreement to issue stock, or if you simply have questions, we'd love to help. Feel free to reach out using the contact form at Fallone SV!

*This blog provides general information for educational purposes only. It is not intended to constitute specific legal advice and does not create an attorney-client relationship.*

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