Understanding Vesting Agreements

What are vesting agreements?

Most startups are founded by founders who are colleagues or school mates.  When selecting a co-founder, you are essentially entering into a long term business arrangement that may last for 7 to 10 years or more.  One way to see if you work well with your co-founder will be to work on a common business plan or business one pager together to see if both of you are equally committed to the new venture.

But as time continues, founders may quarrel or one founder may need to leave the startup to look at other things.  So there is a possibility that a co-founder may leave the start-up halfway still holding a lot of shares.  This results in communism and the existing founder and employees will find it hard to continue working hard for the startup and have free-loaders still holding the majority of the shares of the company even after they have left the company.

One common legal provision to deal with the situation whereby a co-founder leaves early in the life of a startup is a vesting agreement clause.  Such a provision is usually inserted into a founders’ agreement or a shareholders’ agreement. 

#1: What are vesting agreements?

This is provision that allows the remaining founder to acquire non-vested shares of an employee or a co-founder that intends to leave the company at a nominal price per share.  For vested shares, it’s a commercial decision what price the remaining founder can acquire such shares for per share and usually it’s a discount to the latest funding round of the company (if applicable). 

#2: How many shares can be bought back by the remaining co-founder?

The buy provision in the vesting agreement clause will usually set out a vesting schedule.  The co-founder or employee will have to see how many shares have vested at the point of leaving the startup.

#3: What is the difference between acquiring shares of a founder for cause and not for cause?

Some vesting provisions will divide the scenario of acquiring shares of a co-founder for cause from acquiring shares not for cause.  Shares acquired for cause will usually be acquired for nominal consideration while shares acquired other than for cause will be bought at the market price. 

What then is “for cause”, this is usually when a co-founder employment is terminated or is forced to resign usually for illegal activities carried out by the co-founder.

#4: What is the usual schedule for vesting agreements?

The usual vesting provisions are for 4 years.  In the first year there is a cliff, so if the founder leaves the employment of the company before the first anniversary, all the shares held by the founder will be forfeited.  Thereafter there is usually a vesting period for 3 years.  During this 3 years, parties may consider having a 6 monthly vesting schedule or monthly schedule. 

In conclusion, drafting a vesting schedule requires technical knowledge from a corporate lawyer that is very familiar with startup work.  There are many corporate law firms that are more familiar with private equity deals than startup work so may not be familiar with the intracies of drafting startup documentation.  Thus, finding a good startup corporate lawyer in Singapore is important for your startup.  Once you get the equity part of your startup wrong, this may affect fund raising in the future and be vest costly from a financial perspective of the founding team.

We are always open to questions on issues relating to startup law in Singapore so if you have any comments on our article, please leave a comment below.

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