When founding a start-up, the commitment and involvement of the founding shareholders are crucial to the project’s success. However, personal and professional circumstances may change, making it impossible to guarantee that all shareholders will contribute consistently over time. To protect the company and the other shareholders from these eventualities, there is a mechanism known as vesting of shares.
Vesting is a legal concept that conditions the full acquisition of rights to shares by a shareholder to certain pre-established timelines or milestones. This protects the start-up from the risk of a shareholder leaving the project or ceasing to add value, thus avoiding the undesirable “dead weight” or “dead equity” scenario, where an inactive shareholder retains their share in the company.
How Does Vesting Work?
Vesting is usually formalized in a Shareholders’ Agreement, generally establishing a vesting period (or maturity) for shares, typically spanning three to four years, with an initial one-year cliff. During this first year, the shareholder does not vest any rights over the assigned shares. After the first year, the shareholder begins to progressively acquire shares over the next three years.
This structure ensures that, if a shareholder leaves the project before meeting the established timelines, they will not take the entirety of their equity with them.
Why is Vesting Important for Start-ups?
Vesting is not only a tool to avoid conflicts among shareholders but also provides assurance to potential investors. Investors seek stability in the founding team, as the dedication and longevity of the shareholders are key factors in a start-up’s viability.
A well-designed vesting agreement ensures that the founding team remains committed to the company’s long-term growth.
Additionally, vesting can apply not only to shareholders but also to key employees through stock option plans or phantom shares. These incentives help attract talent without requiring high salaries in the early stages, aligning employees’ interests with the company’s growth. As the start-up grows, employees consolidate their rights over the assigned shares, strengthening their sense of belonging and commitment to the project.
Accelerated Vesting
Certain scenarios may allow for vesting acceleration. A common example is when an investor acquires control of the start-up, which may require some shareholders or key employees to vest their shares before the agreed timeline. Similarly, signing a strategic contract or selling the company may trigger accelerated vesting.
Reverse Vesting as a Founders’ Protection
While vesting is often associated with employees and shareholders who acquire equity progressively, there is also the concept of reverse vesting, aimed at founding shareholders. Unlike traditional vesting, where shareholders gradually acquire equity, reverse vesting requires founding shareholders who already own equity to agree to return part of their shares if they leave the company within a specified timeframe.
This type of agreement is also essential to ensure that founders remain committed during the start-up’s critical early years, providing an additional layer of protection against unexpected departures.
Vesting and reverse vesting are essential tools for protecting a start-up’s stability and growth. These structures align the interests of shareholders, employees, and investors, preventing conflicts and ensuring that key individuals remain committed to the project.
Our firm has extensive experience in drafting Shareholders’ Agreements and structuring mechanisms such as vesting and reverse vesting. If you need guidance on how to structure these agreements or on any other legal aspect of your start-up, please do not hesitate to contact us.
