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Reverse vesting occurs when a company’s co-founder receives his or her shares and ownership interest upfront. This exchange is subject to vesting similar to employee stock options. When founders launch a start-up, they immediately get equity. Reverse vesting ensures that if a founder leaves the company before the specified period is over (usually four years), the company can purchase its share of equity for little to no cost.
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The purpose of reverse vesting is clear. It ties founders to their start-ups and protects the company, co-founders, and investors. If founders were to leave and take their portion of shares with them, the start-up could quickly tank. It could also prevent the company from attracting future investors.
A reverse vesting agreement motivates founder commitment. Founders know that the only way to hold on to their shares is to continue with the company for four years.
Not all start-ups last four years, but a founder who is invested in the company will work hard to ensure its success. A founder who leaves after four years can still hold on to his shares, which means that the success of the company is in everybody’s best interest.
Without a reverse vesting agreement, a founder who owns the majority of shares and leaves would essentially dismantle the start-up. With a reverse vesting agreement, however, a founder can leave and the majority of equity would revert back to the company, thus protecting other investors and employees.
With reverse vesting, the founder doesn’t take ownership of the shares until the waiting period is over. This reduces the tax burden on the founder, since the shares are acquired at a later date. It also means that the founder’s worth can go up as the shares of the start-up increase in value
Investors are attracted to strong leadership as much as they are to specific products. A reverse vesting agreement increases the likelihood that a founder will stay with the company, which is what investors want.
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An agreement must provide a fair balance between founders and investors. The good-leaver clause is the method to do so. The term is what it states: A founder leaves in a good way. As long as that’s true, the founder won’t lose unvested shares.
Should a founder quit, he or she gives up unvested shares. Should the person get fired, he or she keeps the unvested shares, except in one instance. A founder fired for cause again loses his or her unvested shares. The goal is for a founder’s exit from the company to not damage the reputation of the business. As long as that happens, he or she can keep the unvested shares.
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