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, with a one-year cliff); 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 keep nothing (0%) due to the standard one-year cliff.  Moreover, if there were no cliff and the shares vested immediately, Paul would 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.  Based on the foregoing, Mark would thus hold 100% (or 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.

Secured By miniOrange