Founder vesting – aligning incentives and safeguarding equity

In venture capital deals, founder vesting is a critical mechanism that ensures the founders’ commitment to the business while safeguarding the company’s equity structure. Vesting provisions create a framework where founders earn their equity over time, incentivising long-term dedication and protecting the company from the impact of a founder’s early departure.

For both founders and investors, understanding the nuances of founder vesting is essential. Investors want to ensure the founding team remains incentivised and aligned with the company’s growth, while founders need clarity on how vesting terms affect their ownership and control. This article in our ‘Anatomy of a term sheet’ series explores how founder vesting works, its typical terms, and how it is structured in venture capital documentation.

What is founder vesting?

Founder vesting is a mechanism where a founder's equity is earned over a defined period or upon achieving specific milestones. While founders may initially hold shares in the company, vesting ensures they "earn" ownership over time. 

If a founder leaves the company before fully vesting, the unvested shares can typically be repurchased by the company or redistributed among other stakeholders.

Vesting is often coupled with leaver provisions, which distinguish between "good leavers" and "bad leavers," defining how vested and unvested shares are treated upon departure.

Key components of founder vesting

Vesting period

The standard vesting period is four years, with the first tranche often subject to a one-year cliff (see below).

After the cliff, shares typically vest monthly or quarterly.

Cliff period

A cliff is a set period (usually one year) during which no shares vest. If a founder leaves during the cliff, they lose all unvested shares. This ensures that founders earn their equity by demonstrating a commitment to the company.

Accelerated vesting

Founders may negotiate for acceleration provisions in certain scenarios, such as a sale of the company or termination without cause. They generally come in two forms:

• Single trigger acceleration: all unvested shares vest upon a specific event (e.g., sale of the company).
• Double trigger acceleration: vesting is accelerated only if two events occur (e.g., sale of the company and termination without cause).

Leaver provisions

• Good leaver: typically, someone who departs due to circumstances outside their control (e.g., illness or retirement). They retain vested shares and may negotiate to retain unvested shares in part or full.
• Bad leaver: typically, someone who departs voluntarily or is terminated for cause. They lose all unvested shares, which may be repurchased by the company at nominal value.

Reverse vesting

In many cases, founders already own shares at incorporation. Reverse vesting provisions claw back unvested shares if the founder leaves before completing their vesting schedule.

Why is founder vesting important?

For investors

Founder vesting protects investors by ensuring that founders remain committed to the business. If a founder leaves early, the unvested shares can be redistributed to attract new talent or investors.

For founders

Vesting provides clarity and alignment. It ensures all founders contribute equitably over time, preventing situations where a non-contributing founder retains significant equity.

Practical considerations for structuring founder vesting

Duration and cliff

The vesting period should balance founder commitment with the company’s long-term goals. A four-year schedule with a one-year cliff is widely accepted as market standard.

Leaver definitions

Clearly define good leaver and bad leaver scenarios to avoid ambiguity. Founders should negotiate fair treatment in cases like termination without cause.

Acceleration

Founders should negotiate for double-trigger acceleration in exit scenarios to ensure fairness, while investors typically prefer no or limited acceleration to preserve equity for future hires.

Reverse vesting

Reverse vesting provisions should align with the initial share allocation, ensuring that each founder earns their equity over time.

Analysis: founders’ perspective vs investors’ perspective 

In summary

Founder vesting is a cornerstone of venture capital deals, aligning incentives between founders and investors while safeguarding the company’s equity structure. By structuring vesting provisions carefully and negotiating fairly, founders can retain equity aligned with their contributions, and investors can ensure the founding team remains committed to the company’s success.

Read the next article in our ‘Anatomy of a term sheet’ series, where we explore leaver provisions, examining how they protect the company while balancing fairness for founders. 

If you're navigating the complexities of venture capital term sheets or preparing your business for investment, our experienced team is here to help. Get in touch to discuss how we can support you in securing the right deal for your business.