Founding a company comes with a lot of consideration for entrepreneurs. One such consideration that Idaho and California founders must think through is how to issue stock in the company.
Although the term “founder” has no legal significance, it is usually used to refer to an entrepreneur who generated the initial idea for a business and formally created the legal entity. At the time of formation, companies generally issue 10 million shares, but this number can vary. Founders can pay a modest price (usually less than a penny per share) for shares, this is called “founders stock”.
But what happens if the founder quits or gets fired? In this case, the company buys back the stock at the purchase price (remember, this is often less than a penny per share). If the value of the company has significantly increased, the repurchase of the stock at such a low price can be detrimental and lead to forfeiture. To prevent this from happening, the company will sell the founder “restricted stock” meaning that it is earned over time.
This is where vesting becomes a beneficial strategy for issuing stock. “Vesting” is the issuing of stock over time at a specified rate. The typical vesting schedule is four year vesting with a one year cliff. A cliff is an amount of time in which no stock is issued. This means that the founder receives no shares up front, then receives 25% of the shares after 1 year, and receives 1/48 of the shares every month thereafter.
Vesting helps prevent startups from getting in detrimental situations where they have sold significant shares to the founder and then has to purchase the shares back at an undervalued price once the founder leaves. With a proper vesting schedule the founder receives shares as he or she works for the company and there is less risk for the company if the founder leaves before it was initially anticipated.
