Yokum Taku’s Take On Vesting
A lot’s been going on over at BuzzPal these past couple of months. Besides design and development work, we’re growing the team, forming a new company, negotiating terms, drafting documents, and generally working through all the administrative stuff you gotta do to get a clean start.
One of the questions everybody goes through at this point is: “Who should get how much equity and under what terms and conditions and vesting”? Yokum’s article (below) is about that “vesting” part (other parts to be discussed some below).
Yokum suggests standard 4-year vesting with a 1-year cliff, then equal monthly vesting. It’s hard to argue with that. Indeed, it’s what I got at MCG (I got options that where converted to restricted stock before our IPO in 2001) and it’s most people get if and when they get equity.
“[T]he most fair and equitable structure, and the one that maximizes the alignment between the founders and the investors, is to vest like this:
- 50% of the shares daily over a three year period; and
- the other 50% when there is a sale of the Company.
- All vesting for senior employees accelerates on a sale of the Company”
That last point, and items related to it, is especially important in light of the fact that founders can, and often are, forced out after institutional investors come in. Steve Blank and others covers that issue thoroughly (just do some poking around).
Along those lines, Adeo Ressi (TheFunded.com) and Yokum came together to draft a set of model documents and sample term sheet for The Funded Founder Institute. See the TechCrunch article. Also see Basil Peter’s One Page Term Sheet for Angel Investors and his description of Exchangeable Shares (vs. a convertible note).
Those documents contain many founder-friendly clauses, such as super-voting stock, that may ultimately be bargaining chips for future negotiations, but that is valuable in and of itself. Put it in and let ’em (the VCs) negotiate it out later, if they have “hand” (Sienfeld video clip). If you have hand, it stays in. If hand is split evenly, then you trade with your chips. In any case, check out all those documents and links.
While I’m on a link roll, here are a few more of interest. These links, and their links, will take you to great slides, videos, podcasts, and more:
- “Open Source Series AA Equity Financing Documents From Combinator“: Yokum, I believe, also worked on these.
- Steve Blank’s Blog: Steve wrote this excellent book, The Four Steps to Epiphany, which is getting a lot of press these days (most recently today on TechCrunch UK).
- “What is customer development?“: By Eric Ries. Eric is one of Steve’s disciples, you could say. Another is Sean Ellis.
- “How to develop your customers like you develop your product“: This is the one with the Easter Eggs for you (follow the links there).
- “Early Exits“: Basil Peters’ new book. Note: He covers most of the stuff in that book on his blog.
- Pivotal Tracker: The word of the day from July 8th.
There’s a lot more to say on all these subjects, but I must close for tonight. Before I close, however, let me quickly tell you where I come out on the vesting question:
- Vesting over 3-4 years, with a 6-month cliff for the first 1-2 team members and a 1-year cliff for those who come later.
- Vesting ramps up from a smaller amount per unit of time in the beginning to larger amounts per unit as time passes. In other words, you vest at an accelerating rate instead of a flat rate, like you do with a normal vesting schedule (4-year with 1-year cliff then equal monthly).
- I like Basil’s idea about a 50% holdback until the sale of the company (see his blog post for the reasoning on that).
- Some vesting acceleration for change in control (if there is a termination involved).
- No other acceleration.
Now on to Yokum’s article:
What should the vesting terms of founder stock be before a venture financing?
July 19, 2007
I think that founders stock before a venture financing should be subject to the same general vesting terms as one would expect after a venture financing. A typical vesting schedule is four year vesting with a one year cliff. This means that 25% of the shares will vest one year from the vesting commencement date, with 1/48 of the total shares vesting every month thereafter, until the shares are completely vested after four years. The vesting commencement date can be the date of issuance of the shares, or an earlier date, in order to give the founder vesting credit for time spent working on the company prior to incorporation and/or issuance of the shares.
Some founders want to accelerate vesting upon a termination without cause or a constructive termination. (I will get around to defining these terms in future posts.) I’m not sure that this is really in the best interest of the founders. It is extremely difficult to terminate someone for cause, so termination of a founder will generally result in his/her shares being vested. For founders that have never worked with each other, I would generally counsel against acceleration of vesting upon a termination without cause or a constructive termination. If personalities clash or things don’t work out and a founder needs to be forced out, the remaining founder(s) will kick themselves for allowing the departing founder to leave with a significant equity stake.
If there is acceleration upon a termination without cause or constructive termination, I think the amount of acceleration should be similar to the amount of severance that a person may receive in the same situation. If six to 12 months of severance might be justified if a person is terminated without cause, then six to 12 months vesting acceleration seems reasonable. Of course, the typical norm in technology companies is that there is no severance in any situation.
In addition, some founders may want to accelerate vesting upon a change of control. Single trigger change of control vesting means that the shares accelerate upon a change of control. This isn’t in the best interest of investors because the fully vested founders have little incentive to continue to work for an acquiror after a change of control. In order to incentivize these people, additional options may need to be granted, which increases the cost of the acquisition to the acquiror, potentially to the detriment of the investors. Double trigger change of control vesting means that the shares accelerate upon a change of control AND the founder is terminated without cause or a constructive termination occurs within 12 months of the change of control.
The amount of shares that accelerates upon these events can be 100%, or written as a certain number of months of vesting, such as twelve. I’ve had one VC express a strong opinion that the amount of vesting upon one of these events should not be 100%, but rather 12 to 24 months of vesting acceleration, due to the fact that it is extremely difficult to terminate someone without cause. I think that double trigger 100% acceleration for founders or certain executives is fairly accepted among investors. However, extending that protection to rank and file employees is not common.
In any event, VCs are likely to impose their own vesting terms and acceleration upon a Series A financing, so it may not matter what terms are implemented when the initial founders shares are issued. However, reasonable vesting and acceleration terms may survive the Series A financing, especially if it would be difficult to renegotiate with a critical founder in a team with multiple founders.