Did you know…
that “founders’ shares” could play a major role in structuring your start-up?
by Shilpa Iyyer
Let’s be clear upfront: legally speaking, there is no such thing as founders’ shares. Corporate codes do not mention or define this term, and certificates bearing the words “founders’ shares” do not exist. That being said, the phrase has undeniable practical significance for start-ups and early-stage companies. Founders’ shares represent shares of common stock that are issued to the early participants in the formation of a company. These are the folks who have helped evolve the idea of the company into a reality and have taken significant personal risks in the process. “Founders’ shares” are generally issued at a nominal price – usually the par value set per share.
Here are a few important considerations when determining how to allocate “founders’ shares”:
- Establish appropriate vesting schedules. Vesting stock over time is a mechanism that incents founders to continue contributing to the company in the long-term. Without an appropriate vesting schedule in place, a founder who departs after a brief stint with the company may continue to retain substantial equity and sit on the company’s cap table well past their value. In this way, vesting schedules (and cliff periods) can help protect the company from free-riders. Your advisors can give you a sense of “what’s market” and also help tailor alternatives for unique situations.
- Beyond vesting, consider which other special restrictions and rights are appropriate for you and the founding team. Based on their vision of the company’s growth, team dynamics, and other factors, the founders can agree that certain exclusive rights make sense to include in the founders’ stock grants. You may want to address board seats, super-voting rights, rights of first refusal on founders’ shares, lock-up agreements, accelerated vesting rights upon sale of the business, and co-sale provisions. These terms can meaningfully differentiate the founders’ rights and privileges from those of other holders. In terms of frequency: accelerated vesting, rights of first refusal, and lock-up agreements regularly appear in founders’ stock agreements; co-sale provisions are slightly less common, and super-voting rights are relatively rare.
- Overall, allocate equity with an eye toward company growth. As the company grows, more equity will be issued to recruit and retain talent. These additional employees and participants will have risked less than the founders by joining an established company. Initial allocations should be designed to respect founders’ seniority and maintain meaningful control of the cap table even as new equity is issued.
The starting equity structure of your company is foundational and should be designed to ensure cohesion and collaboration. We advise you to discuss these matters with your financial and legal advisors to determine what set-up makes most sense for your business.