When co-founders start a business, splitting the shares equally on day one can feel like the natural thing to do. But what happens if one founder leaves after six months, or stops contributing while the others keep building? In this video, we explain how vesting agreements make sure equity is earned over time and reflects each founder’s real contribution. We cover the difference between traditional vesting and reverse vesting (often the preferred route for UK founders), how “dead equity” can put off investors, and how good leaver and bad leaver provisions affect what a departing founder is paid for their shares.
A note on our presenter: the Mark Glenister presenting this video isn’t quite the real Mark Glenister. He’s an AI-generated version of Mark: same face, same voice but never needs a coffee break. The real Mark (and the rest of the JPP Law team) put together the legal content, so you’re in good hands, whether they’re human or digital.
No Sound? Here’s the transcript…..
When founders start a business together, there’s usually a lot of excitement.
Everyone is committed.
Everyone believes they’re in it for the long haul.
And because of that optimism, many startups make critical mistakes in relation to the ownership of shares in the company.
They, for example, divide the shares equally on day one.
But what happens if one founder leaves after six months?
What happens if one founder stops contributing while everyone else continues building the business?
Should that founder still own a large percentage of the company?
Does the reason why the founder has stopped contributing matter?
For many startups, not thinking about issues like this is where problems begin.
And that’s exactly why vesting agreements exist.
In simple terms, vesting means that ownership of shares is earned over time rather than being granted outright on day one, and this can be achieved in a number of ways.
A vesting agreement is designed to ensure that the equity a found retains reflects the founder’s contribution to the business on an agreed basis.
A share being ‘vested’ means that a founder owns a share, and it cannot be taken away from the founder on a compulsory basis.
Often founders’ shares become vest over an agreed period and sometimes this also tied to the founder meeting targets or producing key deliverables in accordance with a business plan.
The aim is to ensure that ownership as between founders remains aligned with the people who are actively helping to build the company in the ways they agreed.
Without a vesting arrangement, a founder who leaves shortly after incorporation could still retain a significant ownership stake.
That can create problems when raising investment.
It can affect future decision-making.
And it can be incredibly frustrating for the founders who continue putting in the work.
Investors often refer to departed founders who still have a significant shareholding as “dead equity”.
It is shares sitting with someone who is no longer contributing to the growth of the company and often did not contribute to the extent that they had agreed with the other founders.
A well-structured vesting agreement helps prevent and remedy this situation.
There are two main types of vesting arrangements, and it’s important to understand the difference.
The first is a traditional vesting arrangement.
Under this approach, shares are earned gradually over an agreed period. Rather than receiving all of their equity on day one, a founder acquires ownership over time as they continue contributing to the business.
The second is known as reverse vesting.
With reverse vesting, founders receive all of their shares at the outset. However, the some or all those shares can be subject to forfeiture if a founder leaves in certain circumstances. This could mean just leaving before the agreed vesting period has expired but the triggers are usually more complex
In practice, reverse vesting is often the preferred approach for startup founders who are individuals who are tax resident in the UK
In reverse vesting, the founders appear on the company’s cap table as shareholders from day one, which provides g the certainty over ownership that investors require.
At the same time, the business remains protected if a founder leaves earlier than expected or does not contribute to the business as agreed.
For example, imagine two founders each receive fifty per cent of the shares when the company is formed.
They agree that their shares will vest over a four-year period.
If one founder leaves after only six months, the other founder may have the right to buy or company may have the right to buy back most of their shares.
If they leave after two years, they may keep the proportion that has vested, while the other founder or the company buys back the remainder.
The result is a fairer outcome for everyone involved, adn the price paid for the shares usually depends on whether the founder is a ‘good leaver’, ‘bad leaver’ or sometimes an ‘intermediate leaver’ in accordance with relevant agreement, which is usually a founders agreement, shareholders agreement or vesting agreement of some kind.
Usually, good leavers are paid the ‘fair value’ for their shares, and bad leavers either receive the nominal value of their shares or nothing at all depending on the mechanism for forfeiting shares
The remaining founders are not left building the company to the benefit of a departed founder who still has a large shareholding, if any at all. .
And future investors see a cleaner and more attractive ownership structure.
Vesting and reverse vesting arrangements also help reduce founder disputes.
One of the biggest causes of conflict within startups is differing levels of commitment.
The team’s expectations should be clear from the outset.
Vesting arrangements can also be particularly valuable when one founder is contributing full time, while another is contributing part time, or where founders are bringing different levels of experience, investment or expertise to the business.
A properly structured vesting arrangement creates fairness and accountability from the beginning.
Of course, every startup is different.
The right vesting structure will depend on the founders, the business model, future fundraising plans and the long-term objectives of the company.
That’s why it’s important to get the legal documentation right from the beginning.
A properly drafted vesting arrangements can protect the founders, protect the company and create a stronger platform for growth.
If you’re starting a business with co-founders, or reviewing your existing ownership structure, taking advice on vesting arrangements early can save significant problems later.
The team at JPP Law regularly advises founders, startups and growing businesses on vesting agreements, reverse vesting arrangements and shareholder structures designed to support long-term success.
Getting these foundations right today can make all the difference tomorrow.
So how can JPP Law help a startup with vesting?
One of JPP Law’s startup lawyers can help you to structure the vesting arrangement. We will help you identify risks you may not have considered and then help you to formalise it through a vesting agreement or by inclusion in another document such as your Articles of Association, Founders Agreement or a Shareholders Agreement.
We take a look, at each of these document in our next video.
If you’re starting a new venture, it’s always worth getting legal advice early.
This is why at JPP Law, we offer an initial complimentary consultation. We can guide you through the legal decisions you need to make, and provide a fixed fee quote for any legal documents you may need.
On our website you will find an online booking system where you can arrange that complimentary legal consultation, and you will find a link to our website in the comments below.
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Thanks for listening!
