NOTE: This is the seventeenth post in our series about standard terms in early stage equity financings. These posts refer to the model Series A Term Sheet put out by the National Venture Capital Association (NVCA) and available for download here.
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Investors often want at least a portion of the stock owned by each founder of a company to be subject to vesting and a corresponding company buyback right if the founder ceases to be employed by the company within a certain period of time after a financing (the “vesting period”). The purpose of the buyback is to incentivize the founder to continue working for the company until the end of the vesting period (when a new equity incentive grant is usually made). This benefits not only the investors, but also the other stockholders (including the other founders) because shares repurchased by the company upon the departure of a founder will proportionately increase the value of all remaining shares.
The standard vesting term for equity incentive grants in an early stage company, such as options granted to employees, is four years, with 25% of the grant vesting after one year (this is called a “cliff”) and the remainder vesting monthly or quarterly over the remaining three years. The NVCA term sheet’s “Founders’ Stock” provision follows this basic formula for the vesting of founders’ stock. If, however, the founders have worked for the company for a reasonable period of time before the financing (typically a year or more before a Series A financing), investors are often willing to exempt a portion of each founder’s shares from vesting (usually up to 25%), while allowing the remainder to vest monthly over three to four years (with no cliff). In addition, founders are often able to negotiate for full or partial acceleration of vesting if (a) the founder quits for “good reason” (generally defined as actions by the company that adversely affect the founder’s employment), (b) the company fires the founder without “cause” (generally defined as bad acts by the founder) or (c) the company is acquired. In the case of an acquisition, acceleration may apply upon the occurrence of the acquisition (called “single trigger” acceleration) or only if the founder’s employment is terminated (usually without cause or for good reason) within a certain period of time after the acquisition (called “double trigger” acceleration). The specifics of accelerated vesting – including the definitions of “cause” and “good reason” and the choice of single or double trigger acceleration – are typically negotiated during the drafting of the transaction documents rather than at the term sheet stage.
It is also important to understand the extent of the company’s buyback right. The company will always have the right to repurchase any unvested shares from a founder if the founder’s employment terminates for any reason (typically at the price the founder paid for such shares), but some investors may also want the company to have the right to buy back vested shares (typically at a price equal to the fair market value of the company’s common stock at the time of termination). Founders should strongly resist giving the company the right to buy back vested shares under any circumstances, but founders sometimes agree to allow the company to buy back vested shares upon termination for cause in exchange for acceleration of vesting if the founder’s employment is terminated without cause or for good reason.