The Importance of Vesting Schedules – Part 2

by Scott Edward Walker on February 6th, 2016

Zuck at Harvard

“I didn’t even know what a vesting schedule was… [and] that mistake probably cost me billions of dollars.” –Zuck

THE MOST COMMON LEGAL MISTAKE MADE BY STARTUPS

Two months ago, I wrote a post on the importance of vesting schedules for the founders and shared the clip below from my legal workshop, “The 5 Biggest Legal Mistakes That Startups Make”.

Indeed, the failure to set-up vesting schedules is now the most common legal mistake I see startups make.  Just in the last week, I received three phone calls from potential new startup clients who had issues between the co-founders and no vesting schedules.

As I previously discussed, vesting schedules are designed (i) to incentivize the co-founders by granting them the opportunity to “earn” their equity over time (typically four years, on a monthly basis); and (ii) to protect the company in the event a co-founder leaves, whether voluntarily or involuntarily.

For example, if Mark and Paul launch a startup and split the equity equally, Paul should not be able to quit the company in six months and keep his 50%.  This is exactly what would happen without vesting schedules.  On the other hand, if standard vesting schedules were put in place, Paul would only keep about 6% of the total outstanding equity (6/48 x 50%), which he would be deemed to have earned by working for the company for six months.  The other roughly 44% of the equity that he holds would be repurchased by the company at its original purchase price and would be available for future issuance.  Mark would thus hold 94% of the equity, subject to future dilution.

No sophisticated investor will put money into a company in which a substantial portion of the equity is owned by a co-founder who no longer works there.   Thus, without vesting schedules, Mark’s only option would be to negotiate with Paul to repurchase his stock, which can often be difficult/contentious (e.g., if Paul left on bad terms) and/or costly.  Just ask Mark Zuckerberg:

“I didn’t even know what a vesting schedule was… [and] that mistake probably cost me billions of dollars.” –Zuck (see video below starting at the 19:36 mark)

p.s. Zuck is a brilliant entrepreneur (and I am a big fan of his).  The lesson, of course, is that even a superstar like Zuck can make costly mistakes early on – particularly if you don’t have an experienced lawyer involved.  Cheers, Scott

Comments are closed.