When a founding team starts a business, the members have to ask themselves a critical question: how should we make sure they divide the value of the company fairly? There are many ways to do this, but often the simplest is to structure the initial shares as vesting.
Vesting shares means an individual does not have the right to all of the shares up-front, but instead earns them over a defined period of time. Typically, the vesting occurs monthly over four years. The advantage comes down to team alignment. Specifically, the future is difficult to predict and vesting creates a built-in mechanism where everyone’s incentives are aligned to create value over the long term.Vesting shares means an individual earns their ownership over a defined period of time. Click To Tweet
We can break this down into a concrete example. Let’s say your Co-Founders decide to leave in the early stages of your company. There are two different scenarios that will unfold. If you structured your shares as vesting, then your Co-Founders will only be able to take the shares that they have earned from the time they put into the company. However, without vesting, they will get the full value of the shares, regardless of how long they work on growing the company. That means you would increase the value of the company, but they would reap the benefits as if they had made the same contributions as you.
We can use some simple math to make this even easier to understand. Let’s imagine a company with two founders that have 8,000,000 shares broken up as follows:
- Founder Shares CEO: 6,000,000 (75% of founder shares)
- Founder Shares CTO: 2,000,000 (25% of founder shares)
Over a four-year vesting schedule, their shares would be distributed like this:
Here’s another way to think about vesting. Employees at companies don’t get paid 4 years of their salaries up front or in advance. They receive a percentage of that salary at the end of every pay period in proportion to the work they’ve done. When shares are vested, this same system is applied to founders.
In other words, vesting shares sets appropriate expectations and makes sure value is distributed fairly amongst the founders.Vesting shares sets appropriate expectations and makes sure value is fairly distributed. Click To Tweet
Keep in mind that this is only one kind of vesting. Specifically, when you take on outside capital, you may have to negotiate vesting with them. This is a more complicated situation, and one we will cover in a future post. Stay tuned.