Why founders should sign a vesting contract Stefan Zangerle 11. January 2022

Why founders should sign a vesting contract

Why founders should sign a vesting contract
Why founders should sign a vesting contract
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Anyone who founds a company should first deal intensively with the legal framework, the different legal forms and the contractual design options. This is especially recommended if several co-founders are involved in the start-up project. Here it has to be decided how and in what form the company shares will be distributed before the company is founded. In addition to the founding contract, prospective entrepreneurs also have the option of agreeing a vesting contract (which is quite unknown outside of the startup scene). In this post I explain what a vesting contract is, what it is for and why, in my opinion, all startup founders should sign a vesting agreement.

What is a vesting contract?

A vesting contract (or a vesting clause ) is a regulation that enables a company to withdraw shares from the founders. This regulation is particularly effective if founders leave the company prematurely. A vesting period is typically agreed, which the founders must at least stay in the company. In practice, this term is between 3 and 7 years. During this period, the founder has to “earn” his shares by working in the company. What does that mean exactly?

example

Founder A, Founder B and Founder C decide to set up a GmbH. A should receive 50%, B 30% and C 20% of the company shares. In addition to the founding contract, the founders also agree on a vesting contract. The vesting should last 5 years. The founders “earn” 1/60 (5 years = 60 months) of their previously determined shares per month.

After 2 years and 3 months, founder B decides to leave the company because he is no longer motivated. Founder B has thus earned 27/60 of his shares (that is 13.5% of the company) and is allowed to keep them. The two remaining founders now have the right to buy back the remaining 16.5% company shares from founder B.

The “vesting” (in German: the transfer) of the shares should ensure on the one hand that a founder remains motivated in the long term and on the other hand that only those founders are fully involved in the success of the company who also contributed to it.

Good Leaver and Bad Leaver

Two scenarios are also dealt with in the vesting contract. The “good leaver” and the “bad leaver” situation. One speaks of a good leaver when the cooperation is terminated by mutual agreement, the founder withdraws for health / family reasons or for the reasons stated in the contract. One speaks of a bad leaver when a founder has violated the provisions of the contract (e.g. to found a competing company) and leaves the company.

The classification into Good Leaver and Bad Leaver has an impact on the amount of the purchase price of the shares that the other founders can buy back. If the departing founder is a good leaver, he will usually receive the current market price for his shares. In the case of a bad leaver, however, the purchase price is only the amount for which the departing founder also joined.

The pros and cons of a vesting agreement

As already mentioned, the main purpose of the vesting contract is to create a fair regulation for the shares of the founding members. This has the advantage that in the event of a co-founder leaving the company prematurely, there will be no dispute or legal consequences later. In addition, the founders have an additional incentive to stay with the company until the end of the vesting agreement. This offers a certain security not only for founders, but also for investors who support the company with financial means. A vesting clause can therefore often be found in participation agreements for investments.

However, this bond between the founders is also a disadvantage. As a founder, you may have to miss out on one or the other business idea because you are still contractually bound to the old company and you don’t want to lose your shares.

Conclusion

A vesting agreement binds the founders to the startup for a certain period of time. If a founder leaves prematurely, he must offer his remaining shares to the other founders at a certain purchase price.

A vesting agreement thus offers a certain degree of security for both founders and investors. From my point of view, it is therefore generally recommended to all start-ups. The founding team is known to be the “heart” of every startup and the co-founders should make sure that this core team stays with the company for as long as possible.

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