Founder’s stock refers to stocks of a company, which are allotted to the business’s early founders. These shares are generally offered with a predetermined vesting schedule. Moreover, the founder’s stock is available only at face value.
When discussing such stocks, one must understand that ‘founder’s stock’ is not a legalised term, but a simple one to define shares offered to individuals who founded the business. A founder, in this case, can either be the partners of a business or an early investor who helped realise the company’s establishment.
However, before proceeding further, one must understand what a vesting schedule entails when it comes to stock and share ownership.
Features of Founder’s Stocks
Listed below are some common features commonly associated with such stocks:
- Beneficiaries may not receive the said dividend until the ordinary shareholders acquire their earnings.
- These options come with the right of first refusal if a co-founder decides to sell his/her shares.
What is a Vesting Schedule?
Vesting schedule refers to the time or date when an employee or investor can take advantage of his/her stock options. In the case of founder’s share, the founding member is granted such stock at face value on a particular date. However, he/she is not free to sell or utilise that stock on the grant date. Instead, they would need to wait for the stock in question to vest completely.
In most cases, a vesting schedule lasts anywhere between 3 and 5 years. Nevertheless, this time can vary depending on the share option and the company issuing it.
Benefits of a Vesting Schedule for Founder’s Stock
Companies employ a vesting schedule on founder’s share for a few reasons. Listed below are some of the benefits of locking the share options behind a timed clause –
- Employee retention
Vesting schedule allows companies to retain their employees or shareholders for a significant period, say up to five years. Such individuals can only utilise the stock options after full vesting of the stock is complete. Thus, choosing to seek employment elsewhere would mean surrendering the rights to these founder’s stocks. Beneficiaries would never risk losing such stocks by looking for better prospects before vesting ends.
- Resolution of a free-rider problem
A vesting schedule on a founder’s share should protect the interests of the other founders, should one of these elite members decide to part ways. Such a restriction ensures that the leaving member does not acquire unfair benefits from the work put in by the other members of the founding team who stay behind to develop a business. Thus, vesting of founder’s share can eliminate the risk of an ex-employee becoming a ‘free-rider.’
Allocating Founder’s Stock
Fairness is integral for effective distribution of founder’s stock. Listed below are the different layers into which a business can divide its founding members for the purpose of fair allocation of such shares.
- Topmost layer – The first layer should consist of founding members who came together to start a business. These individuals should have started working on this concerned firm at the same time, facing the initial risk of leaving their employment to set-up the organisation.
- Second layer – This layer should comprise of the very first employees for this business in question. Since these employees faced a lower risk than the initial founding members did, they should be entitled to limited allocations.
- Third layer – This last layer should consist of employees recruited later when the business was already earning hefty profits and doing well. With a minimal contribution to the company’s overall success, this layer should be entitled to the lowest amount of founder’s shares.
In an effective organisation, the first layer of founders should acquire around 50% of the equities. Each subsequent layer after that, on the other hand, should receive 10% of these stocks. Generally, a company goes public around four or five years down the line, by which time, there can be as many as five layers.
Effects on Unvested Stock if Employees are Fired or the Business Dissolves
A vesting schedule may undergo acceleration in some instances. Acceleration can take place in one of two ways –
- Single trigger – In this case, the vesting is accelerated to the point of a company sale.
- Double trigger – In a double trigger, vesting is accelerated if the company is sold and the employee in question is fired without reason. The only condition is that he/she must be terminated within a stipulated time after the company sale occurs.
The latter option ensures that the vesting schedule is still maintained even after company sale. Only termination without cause can push accelerate the schedule. However, in the single trigger method, company sale immediately leads to vesting of unvested stock.
Control Provisions within Founder’s Share
Founders of a business start to lose control over the company as time passes. Equity capital raising through share issues is to blame for such a thing happening. Fortunately, with founder’s stock, loss of control can be prevented. Such shares may come with special voting rights, such as 20 for 1 entitlement for voting.