Are you in the process of raising funds for your Startup through equity investments? Or are you currently negotiating an Investment Term sheet? A frequent request from investors in such transactions, is that the Founders’ and key employees’ shares should vest in accordance with an agreed vesting schedule. This is typically a clause that Founders would push back on, as it is perceived as a loss of ownership rights in their business, for a certain period of time.
This Newsletter aims to help you understand the concept of Share Vesting. This should enable you make informed decisions when negotiating your Investment Term sheet.
Share Vesting in simple terms means a process whereby a Founder or an employee gains ownership rights in its Company’s shares over an agreed period of time.
Can your shares still be subject to a Share Vesting Clause, even though the shares were allotted to you at incorporation?
Yes, particularly if your shares have not been fully paid for. A share vesting clause is a contractual arrangement, which is binding on the Parties upon execution of the Agreement.
What are the benefits of having a Share Vesting Arrangement?
❑ Fosters Founders’/Employees’ loyalty and retention: It is expected to incentivize Founders and employees to diligently work for the business for a minimum period of time.
❑ Protects the Company and prevents dilution of shares: Where a Founder or an employee leaves the Company, the unvested shares are returned to the Company and the vested shares (subject to contractual terms) may be bought back by the Company at the original price it was sold.
❑ Attractive to Investors: Companies looking to acquire Startups find vesting provisions beneficial, as it incentivizes the Founders to continue working for the business even after an acquisition.
What are the typical types of Share Vesting Arrangement?
❑ Immediate Vesting: This is relatively uncommon for Companies funded by VCs, as vesting occurs immediately and full ownership of the shares are earned.
❑ Cliff Vesting: This arrangement involves a cool off period before the vesting schemes starts and it gives the Founder or an employee full ownership after a certain period of time passes. In the case of Startups, the Cliff period is typically one year (i.e. shares begin to vest after one year).
❑ Graded Vesting: In this arrangement, shares gradually vests over time (monthly or quarterly) without a cool off period and the Founders or employees gradually own shares in the business.
❑ Accelerated Vesting: This occurs in the event of acquisition or merger or other change of control of the Company. In such instances, there are two different approaches to accelerated vesting.
➢ Single Trigger Acceleration: The acquisition or merger triggers the acceleration of vesting, thereby making the equity owner receive the full or partial value of the shares.
➢ Double Trigger Acceleration: Vesting is triggered by the occurrence of two events namely: the Company’s acquisition; and termination of the Founders’ or employees’ contract with the Company. A Double Trigger with a one year acceleration is popularly encouraged as a balanced approach to acceleration.
What are you to look out for as a Founder in a Share Vesting Arrangement?
❑ The vesting commencement date.
❑ The extent of contribution by each Founder.
❑ The vesting frequency (monthly/quarterly).
❑ Length of the vesting schedule.
