In parts one (‘Sharing ownership in start-ups’) and two (‘Establishing ownership and reward in a start-ups company‘) of this series I have touched on the challenges of sharing in business and what I see as a missing link in the start-up journey in the UK – the absence of structured discussion and agreement as to ownership and reward among founders.
In this final part I will look at vesting schedules and how they are being used, and are now regarded as essential, in the US. So what is vesting and how does it work? Vesting in relation to an asset basically means that ownership and associated rights pass to you, or in one definition vested means having ‘an absolute right to some present or future interest in something of value’.
In the case of shares in a company (the most common form for a business in the UK) it means that the shares are yours. The ‘schedule’ part of ‘vesting schedule’ refers to what is usually a table that sets out how many shares will vest and when. There are two kinds of vesting: ordinary (where the shares are issued to you as you go along) or reverse (where a specific share allocation is provided for you but vests as you go along).
Now ‘go along’ can take a number of forms and might include: Time, meaning the time spent working in the company and this can be in days, weeks, months or whatever time intervals are chosen. In the US the norm is for a four-year vesting period with a one year ‘cliff’. A cliff means that nothing vests unless and until you pass a specified date, commonly a year from commencement.
Performance: shares vest on achieving certain milestones or targets, whether individually or as a company. In many situations a start-up does not need to establish a company at the outset (after all, doing so means there will be audit costs to pay and Companies House compliance issues such as appointment of directors, annual returns, etc). Where a company has not been formed what may be needed is a collaboration agreement, an example of which is made freely available by Seedcamp which recently published the second edition of their draft agreement.
The Seedcamp agreement makes no provision as to what happens if a start-up company is not formed, particularly with regard to IP created in the pre-company formation stage. A suitable non-disclosure agreement can provide a base level of recognition and protection for what individuals bring to the table however the new IP (such as in coding or design) created during the collaboration period may be of value to someone and therefore a potential source of dispute.
If noone wants to form a company then it’s better perhaps to let everyone involved make use of what was created and good luck to them. Whatever is preferred it should be discussed and put in writing. Having a draft agreement is not enough, nor is instructing lawyers going to help; if you have not taken the time to sit down together to have a grown up conversation about who is contributing what and what you expect of each other.
If you decide to instruct lawyers they have to know what you want and you can save a lot of time and money if you can thrash things out between you first and write it down (nothing like writing things down to focus minds). Deciding what value to attribute to each person’s contribution is itself a challenge and I have struggled to find resources that report how this is commonly done, save for the toll I came across by chance at www.foundrs.com.
Once at the stage when it is right to create a company, a shareholders’ agreement will be needed to enshrine the terms set out in the collaboration agreement (if there is one). The transition can then be a smooth one rather than having to confront the big questions just at a time when the business is ready to start in earnest. When outside investment is needed the whole share structure and vesting arrangements will be up for negotiation once again; but that is a nice problem to have. There is so much to be explored in this area however it all comes down to the common denominators of income, equity and control and how they are to be shared out among the founders. I believe we need to build awareness of the value of vesting arrangements between founders to ensure that startups start in the right place and from a platform of trust based on open discussion and understanding of mutual expectations.