Want to protect your organization from hoppers? How about Vesting their shares?
Vesting means that the shares are encumbered and subject to cancellation or repurchase at cost by the Company unless certain time events occur. This means that if your partner walks away after incorporation or after a couple of months, he or she will not be able to claim his full share of equity from the company. The ideal vesting clauses typically last four years and have a one year ‘cliff’. A “cliff” represents the minimum period of time that must elapse before your equity begins to “vest,” or, actually begins to be recognized by you. If you leave the company before the cliff has expired, then you will not be able to keep any equity in the company. A cliff period allows one to run the trial and error mechanism and thereby procure the best suited human resource for the organization.
Vesting with a one year cliff means if you had 50% equity and leave after two years you will only retain 25%. The longer you stay, the larger percentage of your equity will be vested until you become fully vested in the 48th month (four years). Each month that you actively work full time in your company, a 1/48th of your total equity package will vest. However, because you have a one year cliff, if one of the founders leaves the company before the 12th month, then he or she walks away with nothing; whereas staying until day 366 means you get one fourth of your stocks vested instantly.
Certain points to focus by start-ups with respect to vesting are:
1. Every member of the team should be subject to vesting.
2. Vesting options should always be framed keeping in mind the “future contribution or expected future contribution” of the member.
3. 20% equity should always be reserved for future investors, angels and likewise while 10% may be reserved for consultants, board of advisers and likewise.
Another good aspect of vesting might be “milestone vesting”. In this, stock vests depending upon pre-decided milestones or performance levels. However, proper caution should be adopted while defining said milestones. The key to an effective milestone vesting will be deciding and expressly stating the aspired milestone without any trace of ambiguity.
An “accelerated vesting” schedule is an alternative option that allows certain members’ equity to vest at a faster rate in the event of some triggering (or double-triggering) event, usually unfair termination or willful departure without good reason. it means that employees at whatever level can liquidate their holdings before the merger occurs, so as to avoid any loss. Sometimes, high-level executives in a failing firm can use this accelerated option as a means of making a quick profit before they are ricocheted from the operation.
Prevention is better than cure. Hence, it is advisable for start-ups to spend some time before registering their company/any other business unit and blanket their interests thereby ensure the financial perpetual succession of the organization.