Partner Predicaments: Vesting
In a continuation of yesterday’s post, I’m going to stay on basic topics that many first time founders seem to overlook. Most founders split equity among the team. That’s good. What they fail to do is put any sort of vesting schedule on their ownership stake. That means that if Charlie & Bob & Pam form a company, they own their stake outright from day one.
Why is this a mistake? Motivations for working change. Charlie might go get married or Bob might have a kid. Suddenly those 80hr weeks that Bob was putting in dwindle to 40hr weeks. Bob still does good work, but he has no additional incentive (from an ownership perspective) to work 80hr weeks if he still is compensated the same amount. Worse yet, Bob may decide that he needs a more stable job because he has a kid now and leaves the company. In leaving, he also takes his equity stake. Now Charlie and Pam need to bring on another employee or partner. To get the best people, they’ll need to entice them with the potential for equity ownership. To do this, they both are going to get diluted. Bob gets diluted as well, but he’s no longer active so it is less important to him. Charlie & Pam are now doing the same amount of work for less equity (with no tangible added value).
How do you solve this? Build a vesting schedule into your founder agreements. Standard practice dictates a 4yr vesting schedule. This is the path of least resistance – it requires little thinking about how to grant stakes to the original founders – if they stay involved at a pre-defined level for 4yrs they will own their entire stake outright. You can get fancy and tie equity grants to specific actions, but I believe this becomes tricky as the value of the company fluctuates and the value of initial actions is always weighed more heavily than later actions.
If you’re about to issue ownership stakes to your partners, stop. At the outset everyone is pulling in the same direction and excited to get started. Make sure that the team is being set up to still be on board in 2,3,10 years!