Founder vesting and why investors ask for it

Founder vesting means that a founder's shares are earned over time, as long as the founder stays and works. If a founder leaves early, the company or the other founders can buy back the unearned shares, normally at a very low price. The founder keeps the part already earned.

This feels odd at first, because founders usually own their shares from the day the company is set up. That is why the standard method is called reverse vesting: the founder owns the shares up front, but the company holds a right to take back the unvested part if the founder leaves. For ordinary employees, options come first and ownership later. For founders, it runs the other way round.

A startup is a bet on a small team working for many years. If one co-founder holds 40 percent and leaves after six months, that person keeps a huge stake in a company they no longer help to run. The remaining team does all the work, and the investor sees a cap table that rewards the wrong people. The investor's money is then at risk because the people who stay lose motivation.

So investors usually make vesting a condition of the funding, written into the share subscription agreement and the shareholders' agreement. Well-prepared founders do not wait to be asked. They set up vesting among themselves at the start, which also protects each founder from the others.

The usual pattern mirrors employee vesting: four years, with a one-year cliff, then monthly steps. Founders who have already worked on the business for a long time often get credit for that time. For example, a founder who has spent two years building the product before the company raised money may start with 25 to 50 percent already vested.

The terms to negotiate are these:

• Vesting period: commonly four years, sometimes three.
• Cliff: commonly one year, though some founders skip it when they have already been working together for a while.
• Starting credit: how much counts as vested on day one, for work already done.
• Acceleration: whether some or all unvested shares vest if the company is sold, and whether it needs a second trigger such as removal from the role.
• Buyback price: the price at which unvested shares go back, often the face value or the original cost.

Leaver clauses say what happens to a founder's shares when they exit, based on the reason. A good leaver is someone who leaves for reasons not blamed on them, such as death, serious illness, or being removed without cause. A bad leaver is someone who resigns early without cause, is dismissed for serious misconduct, breaches non-compete or confidentiality terms, or commits fraud.

A bad leaver may lose all unvested shares and some vested ones too, perhaps at a discount to fair value. A good leaver usually keeps vested shares at fair value and loses only unvested ones. Where to draw these lines is among the most negotiated parts of a term sheet, so read the definitions closely.

In an Indian private company, the founders hold shares directly and sign agreements that give the company or other shareholders the right to buy back unvested shares. A buyback by the company itself must follow the Companies Act, 2013 rules, so many agreements give the right to other founders or to the company's nominee instead. Stamp duty, tax on the transfer and the company's articles of association should be handled by a lawyer.

Founder vesting is different from an ESOP for employees. Promoters are generally not eligible for the employee option plan, with an exception for DPIIT-recognised startups, generally within 10 years of incorporation. Vesting by contract is the main tool for founders.

Vesting matters even more with two founders, because a split can leave a 50-50 company in a deadlock. Setting vesting early, before there is any money or dispute, keeps the conversation friendly. A written agreement on roles, time commitment and what happens if one founder wants out will save more pain than any clause on its own. See also the guide on how co-founders split equity.

Agree on vesting terms with your co-founders in writing at the start, with a lawyer who acts for the company, and review them at each funding round. Ask for credit for past work. Keep the leaver definitions narrow and precise. And remember that vesting is not an insult: it is a standard tool that serious investors expect.

This guide is general information, not legal advice, so check your own agreements with a qualified lawyer.