I met with someone once, who was beside herself that her attorney, one of the best, she claimed, couldn’t fix her problem. Her problem was that she had what she felt was a hot little tech start up that she formed with three people, one of which was now bailing on the company. The problem: the bailing founder had mostly vested, so she owned her shares, but was now not doing much work and wasn’t really incentivized to do so.
This is a common vesting problem. So, founders, here are some common rules when considering your cap table so that you understand what to expect and what to address from the gate as you are working with your lawyer.
1. Ownership isn’t just based entirely on who had the idea or who has contributed to the most so far.
2. Ownership should be based, in large part, on your future contributions to the company.
3. Ownership should vest according to the founder making or doing the expected contributions to the company.
The goal of any vesting arrangement is to property align the incentives of the founders. So founders (and their lawyer) should take care to structure the vesting schedule in a way that accurately reflects the expectations of the founders. Remember: you don’t want too much of the equity to vest until the bulk of what is expected of the founder is complete.
1. What is each person supposed to contribute and when?
2. Is this related to a specific task or building a specific product or is it leadership and guidance that is to occur over time?
3. Has some of it already been provided or occurred?
Common vesting issues faced by startups.
1. The founders have not put their equity arrangements in writing. To this I say -DUH. You wouldn’t believe how often this is a problem. People come with their messy cap tables and undocumented arrangements, and this is a disaster, and it is costly clean-up work for the founders.
2. A founder leaves. This is what happened in the situation I mentioned above. The founder contributed but not as much as the other founders would have liked, and, to make matters worse, her equity fully vested and now there was no incentive for her to keep working towards the growth of the Company. If you don’t have vesting provisions, a founder who leaves the company will retain their initial ownership, which contributing nothing to the company’s growth. This founder can sit and wait for a payday that is unearned and this can lead to loos of momentum for the other founders and becomes an issue for other potential investors who can clearly see what is happening between the founders.
3. Hey! Let’s grant the equity later! This seems to avoid the problem of founders losing incentive to work to grow the company, so let’s just hold off until the company has “made it.” Don’t do this, because this will result in significant tax consequences for the founder since the stock granted at a later date will have significantly more value than if it was granted when the company was formed. Since the founder will receive that stock in exchange for working, they’ll have to pay taxes at ordinary income rates on the value of it when they received it. Often, the founder won’t have the money to pay the taxes on this. To prevent this, stock (subject to vesting) is issued at the very beginning. There are tax forms that need to be filled out to do this the right way, so get some legal help!
As always, this stuff is nuanced and varies according to circumstance.
If you need assistance contact Wick Law Offices, LLC today! 614-572-6366. Email me: email@example.com. Wanna know more? Go to my website:www.mwicklaw.com.
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(Materials in this article have been prepared by Wick Law, LLC for general informational purposes only. This list is for educational purposes and is not to be considered exhaustive. More items could be added to this checklist based upon the type of transaction or industry standards. These materials do not, and are not intended to, constitute legal advice. The information provided is not privileged and does not create an attorney-client relationship with Wick Law, LLC or any of the firm’s lawyers. This checklist is not an offer to represent you. You should not act, or refrain from acting, based upon any information in this checklist. Wick Law, LLC maintains offices in Columbus, Ohio, and has lawyers licensed to practice in Ohio and in the United States District Court, Southern District of Ohio. The firm does not intend to practice law in any jurisdiction where the firm is not licensed.)
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