How to protects founders from each other and aligns incentives so everybody focuses towards a common goal: building a successful company.
You have a great idea and a trusted business partner with whom you want to work. You both work hard for at the beginning until your partner decides to walk away leaving to develop the business alone. You really believe in this idea and keep working hard until things start to turn around. You sell your company for a whopping 200 million dollars.
Next morning your phone rings. It’s your old partner asking for his share of the proceeding because of the 50% you agreed when you both founded the company. Wait! What?
A smart way to solve the above problem is with the use of so-called “vesting” clauses, which are usually incorporated into a shareholder agreement. Under such clauses, a shareholder does not obtain the benefit of the shares until certain conditions have been satisfied, such as remaining with the business for a minimum period of time or achieving a specific milestone (e.g. obtaining a certain revenue target or a number of users). After those conditions are satisfied, the shares or a certain pre-determined percentage of the shares will “vest” in the shareholder. Otherwise, the company may have an automatic right to repurchase the shares.
For example, a “vesting schedule” may provide that shares will vest over a period of 4 years on a monthly basis. Typically, there is an initial “cliff”, whereby a shareholder must remain with the company for a minimum period of time (say, 1 year), otherwise, they will lose rights to all of the shares. Therefore, assuming a standard 4-year vesting period, after the first year, 25% of the shares will automatically vest, with the remaining shares vesting over the next 3 years, in monthly parcels of 1/46 of total shares.
Another issue is if the company is acquired or a change of control occurs before all shares have vested. In that case, a “trigger” clause may be included to accelerate the vesting of the shares upon such change. A “double trigger” clause may provide that the shares only automatically vest if the shareholder is subsequently fired, in order to ensure that they have an incentive to stay with the business after the acquisition.