If there are two or more founders in a startup, an important consideration regarding the initial issuance of equity to the team is vesting of the founders’ equity.
Vesting of the equity issued to founders, usually in the form of reverse vesting, means that if a founder leaves the startup for any reason before a certain amount of time, and the remaining founder (or founders) continues to build value in the Company, the departing founder will not be entitled to the benefits that the full equity ownership of the Company that was originally issued to the founder represents. To say it plainly, with reverse vesting, 100% of the founder’s common stock is issued to the founder at the formation of the startup, but if the founder leaves the startup, a portion of the stock issued to the founder is automatically repurchased by the company at the (presumably low) original issue price.
Reverse vesting protects founders because it attempts to address the free-rider issue—where the departing founder inequitably benefits from the efforts of the other founders—while at the same time acknowledging that a founder should be entitled to some benefit from the success of a company that the founder helped launch.
How to Prepare for an Equity Financing
We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.
What Every Startup Needs to Know
On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.
Surviving the Series A Crunch: Financing Alternatives
The “Series A Crunch,” which is the significant decline in the number of startup companies per quarter that are completing their first equity financing, appears to be deepening.