What is Founder Vesting?
Founder vesting is a mechanism where founders earn their ownership stake in the company over time rather than receiving it all upfront. Under a vesting schedule, founders gradually acquire the right to keep their shares ("vest") by remaining with the company.
If a founder leaves before fully vesting, the company has the right to repurchase the unvested shares at a nominal price (usually the price paid or face value). This protects the company and remaining founders from situations where a departing founder retains significant equity without continuing contribution.
How Vesting Works
- • Founders initially own all shares, but with vesting restrictions
- • Vesting occurs over time according to a schedule
- • Vested shares are fully owned and cannot be repurchased
- • Unvested shares remain subject to company repurchase right
- • If founder leaves, unvested shares are typically forfeited
- • Vesting aligns long-term commitment with equity ownership
Why Founder Vesting Matters
Founder vesting serves critical purposes for startups, investors, and the founding team itself.
For the Company
- • Retention: Incentivizes founders to stay and build the company
- • Protection: Prevents "dead equity" from founders who leave early
- • Recruiting: Allows redistribution of unvested equity to new executives
- • Investor Confidence: Signals commitment from founding team
For Co-Founders
- • Fairness: Ensures all founders contribute over time to keep equity
- • Alignment: Prevents disputes when one founder leaves early
- • Clean Cap Table: Avoids messy cap tables with departed founders
For Investors
- • Risk Mitigation: Reduces risk of founder departure
- • Team Stability: Ensures key talent remains post-investment
- • Standard Practice: Expected in institutional rounds
Standard Vesting Terms
While vesting terms are negotiable, certain standards have emerged in the startup ecosystem.
Typical Vesting Parameters
| Parameter | Standard | Range |
|---|---|---|
| Total Vesting Period | 4 years | 3-5 years |
| Cliff Period | 1 year | 0-2 years |
| Vesting Frequency | Monthly | Monthly or Quarterly |
| Acceleration | Single or Double Trigger | Negotiable |
Example: 4-Year Vesting with 1-Year Cliff
Founder holds 40% equity (4,00,000 shares of 10,00,000):
- • Month 0-11: 0% vested (cliff period)
- • Month 12: 25% vests (1,00,000 shares)
- • Month 13: 27.08% vested (1,08,333 shares)
- • Month 24: 50% vested (2,00,000 shares)
- • Month 36: 75% vested (3,00,000 shares)
- • Month 48: 100% vested (4,00,000 shares)
The Cliff Period
The cliff is a period at the beginning of vesting during which no shares vest. At the end of the cliff period, a significant portion (typically 25%) vests all at once.
Purpose of the Cliff
- • Commitment Test: Ensures founder commitment before equity is earned
- • Co-Founder Fit: Allows time to assess working relationship
- • Early Departure Protection: No equity if founder leaves quickly
- • Standard Practice: 1-year cliff is expected by investors
Cliff Variations
No Cliff (Rare)
Immediate monthly vesting. Founders get equity from day one. Very founder-friendly but rare.
6-Month Cliff
Shorter commitment period. May be appropriate for serial entrepreneurs or late-stage founders.
1-Year Cliff (Standard)
Industry standard. 25% vests at year 1, remainder monthly over next 3 years.
Pre-Vesting Credit
If you've been working on the company before investment, negotiate for "pre-vested" shares representing your prior work. It's reasonable to argue that 6-12 months of pre-investment work should count toward vesting. Document this clearly in the SHA.
Acceleration Events
Acceleration provisions cause unvested shares to vest immediately upon certain triggering events. These protect founders in specific scenarios.
Types of Acceleration
Single Trigger Acceleration
All unvested shares vest upon a single event, typically acquisition or change of control.
- • Pros: Founder-friendly; ensures full payout on exit
- • Cons: Can deter acquirers wanting founder retention
- • Typical coverage: 50-100% of unvested shares
Double Trigger Acceleration
Requires two events: (1) acquisition/change of control AND (2) termination without cause (or resignation for good reason) within a specified period after acquisition (typically 12 months).
- • Pros: Balanced; protects founders only if pushed out
- • Cons: Less protection than single trigger
- • Standard: Most common in growth-stage deals
Acceleration Negotiation
- • Full vs Partial: Accelerate 100% or only a portion of unvested shares
- • Time-Based: Some deals provide month-by-month acceleration post-acquisition
- • Investor Pushback: Investors prefer no acceleration or double trigger only
- • Compromise: Single trigger on 50% + double trigger on remainder
What Happens When a Founder Leaves
The departure of a founder triggers different outcomes based on vesting status and the circumstances of departure.
Vested Shares
Vested shares are fully owned by the departing founder:
- • Cannot be repurchased by the company
- • Remain on the cap table
- • Subject to any transfer restrictions in SHA
- • Subject to drag-along rights if applicable
- • Company may have right of first refusal on transfer
Unvested Shares
Unvested shares are typically repurchased by the company:
- • Company has right to repurchase at face value or nominal price
- • Repurchased shares return to ESOP pool or are cancelled
- • Repurchase right must be exercised within specified time (typically 90 days)
- • If not exercised, vesting may continue or shares may be forfeited
Good Leaver vs Bad Leaver
Many vesting agreements distinguish between different types of departure, with different consequences for each.
Good Leaver
Departure due to circumstances beyond control:
- • Death or permanent disability
- • Retirement at retirement age
- • Redundancy (if applicable)
- • Mutual agreement
Treatment: May retain all vested shares, and some unvested shares may accelerate or continue vesting.
Bad Leaver
Departure due to fault:
- • Resignation without good reason
- • Termination for cause (fraud, misconduct)
- • Breach of SHA or employment agreement
- • Competing with company
Treatment: Forfeit all unvested shares; may be required to sell vested shares at nominal or fair value.
Negotiating Vesting Terms
Vesting terms are negotiable. Here's how to approach negotiations effectively.
What You Can Negotiate
- • Vesting Period: 3 years vs 4 years
- • Cliff Period: 6 months vs 12 months
- • Pre-Vesting Credit: Credit for time before investment
- • Acceleration: Single vs double trigger, full vs partial
- • Vesting Start Date: Date of incorporation vs first investment
Negotiation Strategies
- • Document Prior Work: Show evidence of work before investment
- • Market Comparables: Know what's standard in your ecosystem
- • Trade-offs: Offer on other terms to get better vesting
- • Staged Approach: Agree to standard vesting with review at milestones
- • Founder Track Record: Previous exits may justify better terms
India-Specific Considerations
Implementing founder vesting in India involves specific legal and tax considerations.
Legal Structure
- • Vesting is typically implemented through a Shareholders Agreement
- • Founders hold shares subject to call option by company
- • Call option exercisable at face value for unvested shares
- • SEBI regulations may apply for listed companies
- • For private companies, SHA provisions govern vesting
Tax Implications
- • No tax on vesting itself
- • Tax applies on sale of shares (capital gains)
- • Shares held >24 months: Long-term capital gains (20% with indexation)
- • Shares held <24 months: Short-term capital gains (slab rates)
- • Forfeiture of unvested shares generally not a taxable event