How Founder “Vesting” Really Works
March 6, 2018 | By Kevin Vela
Vesting is the process whereby a recipient of equity earns the equity, or the right to purchase it in the case of options, over time. As I mentioned in my last post, the typical schedule is 4 years with a 1-year cliff.
But if a founder doesn’t actually own the equity on day one, how are decisions made? Well, the trick is that a founder actually does own the equity on day one, but the shares are technically “unvested,” or subject to a “repurchase” schedule.
Example – Ann and Barbara each purchase 5,000,000 shares of Newco on day one. The shares have value, but only a nominal value (usually par value – say $.0001), so they each pay $500 to the company. Ann and Barbara now own those shares from day one, but they also know that it is best practice to subject those shares to repurchase so that if one of them leaves, the company can recover some or all of the shares, depending on how long the founder was at the company.
Thus, they enter into a Restricted Stock Purchase Agreement (RSPA) which gives the company the right to repurchase some or all of the shares, at the same purchase price ($.0001), if the founder leaves before the shares are released from the company’s repurchase right.
When are they released? You guessed it – monthly over 4 years with a 1-year cliff. So if Ann leaves after 11 months, the company writes her a check for $500 and repurchases all of her 5,000,000 shares. If Ann leaves on the 1st day of year two, then ¼ or 1,250,000 of her shares would have been released from the repurchase schedule, and the company would only be entitled to repurchase 3,750,000 from her for $375.
The concept of “unvested” shares works the exact same way – the company would have the right to repurchase whatever shares are “unvested”. You’ll see both “unvested” and “release schedule” used to describe the scenario above, but the docs and intent are the same.
To summarize – founders buy their shares for some nominal price on day one, and the company retains a right to repurchase shares that are not yet released, or not yet vested. The number of shares subject to this right diminishes over time until the founder owns all shares outright, with no further company repurchase right. On the other hand, employees and service providers generally receive options or the right to buy shares in the future – and that right vests over time. Those shares are not actually owned until they are exercised.
Restricted stock subject to a repurchase right is an elegant way for founders to own their shares from day one and ensure that the company’s equity is protected.