How do you avoid common pitfalls or mistakes when setting up your co-founder vesting schedule and cliff?

As I delved into the startup world, I learned that vesting is how co-founders earn equity over time, ensuring commitment to the company's growth. I found the concept of a 'cliff' particularly interesting – it's a period (usually a year) where no equity is vested, safeguarding the company if a co-founder departs early.

Many helpful comments in this section. But not one has noted that in start-ups structured as pass-throughs for tax purposes (LLCs generally but also LP funds), OPTIONS are the wrong choice. Vesting is tied to Incentive Units (sometimes called Restricted Units) which are profits interests for tax purposes. Similar restrictions like 4 years, milestones, cliff etc. are all do-able and smart. But with special equity instead of options. Work with an experienced tax advisor up front to make sure you are making the right choice of entity for your business and to make sure your equity structure clearly reflects the tax and economics your investors need.

Firstly, clearly define the roles, responsibilities, and expectations of each co-founder before determining the vesting structure. Set a reasonable vesting period (typically 3 to 4 years) with a one-year cliff to ensure commitment. Avoid equal splits if there's a significant disparity in contributions. Include acceleration clauses for specific scenarios, such as acquisition or departure. Document the vesting terms in a legally binding agreement to prevent misunderstandings later on. Regularly review and update the agreement as the company evolves. Lastly, seek legal advice to ensure the vesting schedule aligns with local laws and regulations.

-Set a reasonable vesting schedule (typically 4 years) with a 1-year cliff to protect against early departures. -Ensure clarity and fairness in the agreement, with all co-founders fully understanding the terms. -Regularly review and adjust the vesting terms as needed to reflect changing roles and contributions.

I always like to keep things simple when discussing this topic with my portfolio companies. The most common structure is a 4 year vest with a 1 year cliff for ALL founding team members. Anytime I have seen accelerated vesting schedules or no cliff its usually a red flag for me as an investor. Why create potential problems where they don't need to exist. Stick to the basics and focus on customers, revenue and growth. If you find yourself arguing about vesting and cliffs, you don't have the right team in place.

-Balance vesting period length to reflect your commitment while maintaining flexibility, typically opting for 4 years. -Align with industry standards to ensure the vesting schedule is reasonable and competitive. -Set realistic goals that match your long-term expectations and the startup’s needs.

The most standard vesting period will be 4 years, but for co-founders, it can make sense to choose a longer vesting period. One way to think about it is to say: "What is the most realistic timeframe it will take to build a viable company?". For most startups, a "viable company" will likely mean a million dollar annual revenue, +50 employees and potentially multi-million dollar outside investments. Reaching this within 4 years would seem highly optimistic, so it's likely that you'll have a longer vesting period for your co-founders.

The vesting period may commence before the official incorporation of the company and issuance of shares to founders, as founders typically begin working on the ideas weeks, months, or even years before the company's formation. The shares that vest before incorporation or the share grant date can serve as compensation for contributions made by the founders during the pre-incorporation period. However, institutional investors, such as VCs, PE funds, or subsequent investors, may be reluctant to approve or accept vesting schedules commencing more than one year before the company's incorporation. Therefore, it's advisable to set a realistic commencement date based on industry standards and negotiate other favourable terms in lieu.

In my journey of teaching Chinese online and consulting startups, I realized the importance of aligning the vesting period with business goals. I chose a four-year period, considering the time needed to establish my brand and solidify my online course's market presence. I learned to be flexible, understanding that as my business evolves, so might the appropriate vesting period.

When it comes to vesting periods, the standard is typically 3-4 years. This gives you and your co-founders enough time to build something great together. But remember, it's not one-size-fits-all. You need to tailor it to your startup's unique needs and goals. Clearly define each co-founder's roles, responsibilities, and expectations before determining the vesting structure. And avoid equal splits if there's a significant disparity in contributions

-Consider a standard 100% vesting percentage to maintain motivation and accountability among co-founders. -Be cautious with upfront equity to avoid undermining long-term commitment and balance within the team. -Ensure fairness and transparency in negotiations to prevent resentment or misunderstandings among co-founders.

Determining the right equity split among my partners was challenging. I had to weigh contributions, roles, and responsibilities. For instance, the equity split reflected not just capital investment but also the intellectual input in developing my online course.

Ah, the tricky part - deciding how much equity each co-founder should get. It's all about finding the right balance between fairness and motivation. A good rule of thumb is to base it on the value each co-founder brings to the table. If one co-founder is putting in more time, effort, or skills, they might deserve a larger slice of the pie. But be transparent about your decision-making process and make sure everyone is on the same page

Sign a co-founder agreement as soon as possible, this will allow you to get your business on the safer side. A co-founder agreement will be formed by a legal team by both cofounder's mutual discussions, if any mishappening occurs you must execute scrutiny and safeguard the business first. The job of an entrepreneur is to : 1. Safe business first 2. Safe himself/herself from any mishappening

Acceleration clauses can be tricky. They protect your interests in scenarios like termination or acquisition, but they can also raise red flags for investors, especially if they think you’ll vest too quickly and leave. Right now, I’m making sure we balance these clauses to protect both the founders and the startup. It’s about negotiating fairly, ensuring that you’re covered in unforeseen events while not scaring off potential investors by diluting too much equity or making the startup less attractive for acquisition. It’s a fine balance, but essential.

In my startup consulting, I realized the importance of acceleration clauses, especially in acquisition scenarios. I decided on a double-trigger acceleration to balance protection and motivation post-acquisition.

Acceleration clauses protect you in case of unexpected events, like an acquisition or a co-founder's departure. These clauses can accelerate the vesting of shares, ensuring that co-founders are rewarded for their hard work even if things don't go as planned. When drafting these clauses, consult with legal experts to make sure they align with your company's goals.

A main purpose of a vesting schedule is to ensure that employees will not be able to walk away from the company with a disproportionate amount of equity compared to the contribution they made to the company. A common mistake made by founders is to exempt themselves from a vesting schedule, assuming that they will always be part of the company. This often leads to unnecessary complications upon a co-founder's departure, which is a very common occurrence. A proper vesting schedule makes things clear and simple. Every employee, including co-founders, can walk away at any time with a fair and agreed-upon equity distribution that reflects their time and contribution to the venture.

I learned from fellow entrepreneurs about the messiness of co-founder exits. So, I made sure our vesting agreement clearly stated terms for such situations, including share repurchase.

Let's face it, sometimes co-founders go their separate ways. When this happens, it's crucial to have a clear plan in place. Document the vesting terms in a legally binding agreement to prevent misunderstandings down the line. If a co-founder leaves before their shares are fully vested, make sure you can reclaim the unvested portion. But be professional and compassionate throughout the process. Remember, you're all human and emotions can run high sometimes :)

Your vesting schedule and cliff aren't set in stone. As your startup evolves, you may need to revisit and adjust them. For example, if you raise more funding, you might want to extend your vesting period. Or if you achieve significant milestones, you could shorten your cliff. Have regular, honest conversations with your co-founders to ensure your vesting terms remain aligned with your business goals. And make sure to seek legal advice to make sure everything is above board.

I set up annual reviews for our vesting schedule to ensure it remains aligned with our evolving business strategy. Adjusting the vesting terms as our startup grew became a crucial task, especially as I expanded my online teaching and consulting services.

Your vesting schedule and cliff need to evolve with your startup. As you grow, raise funding, or hit key milestones, it’s essential to revisit these terms. Right now, I make it a priority to have regular conversations with my co-founders to ensure we’re aligned. If someone’s performance is exceptional, additional equity or bonuses might make sense. On the flip side, underperformance may require renegotiation. Flexibility is key—what worked when you started may not suit your future goals. Keep the dialogue open to ensure fairness and alignment.

Nothing explains vesting agreements more than Charlie Munger's famous quote, "[s]how me the incentive, and I'll show you the outcome.” Thus, vesting schedules are the perfect tool to properly incentivize the founding team to build a high-quality company while managing co-founder conflict without killing the whole company. For context, co-founder conflict is the second most common reason startups fail to succeed. Discussing these things at the start is crucial because most startups do not realize that it is terrible when things are not working, but especially in this case, it gets a lot worse when things are going well when you have not gone through this process.

Consider implementing redemption rights (also known as clawback provisions) in your equity grants. These rights allow your company to repurchase equity from grantees at determinable prices in the event certain "triggers" occur. Redemption rights are highly customizable. Triggers can vary widely but often include scenarios such as a grantee leaving the company without cause or being terminated for cause. For instance, if a grantee commits fraud, a redemption right might enable your company to buy back (or "clawback") their equity at a nominal price. Given the complexity of equity grants and the potential liabilities involved, you should consult with an experienced business attorney before issuing equity. *This post is not legal advice.

- Seeking Expertise: I didn't hesitate to get legal advice to ensure our vesting agreements were solid and compliant. - Open Dialogue: Maintaining transparency with my team about vesting terms helped in building trust and alignment. - Reflecting on Business Goals: I regularly revisited our vesting schedule to ensure it matched our business objectives and growth. - Caring for the Team: I learned that fair and motivating vesting terms positively impact team morale. - Future-Readiness: Understanding how vesting terms can influence future investment prospects was a crucial lesson in my startup journey.