Complete DIY guide: legal basics for startups (Part 2)
Hello guys! Our blog where we published our first article few days ago (Founders agreement. CEO Responsibilities) had about 16600 unique visitors and something close to 49000 page views. Thanks a lot for your support, it really motivates us to write :) If you haven’t already read the first article, I would highly recommend to do so before reading this one.
This article was inspired by a comment from a person with the nickname “lukasm” on Hacker News. Lukasm asked: “How to avoid rookie mistakes like Zuckerberg’s with vesting?”. Vesting is obviously a very important thing. However, before discussing it, in my opinion, we need to discuss shareholders clauses first, because they set the rules regarding shares at the first place. So, this article will first describe how to prepare and write shareholders clauses and then i will explain vesting and show how we did it at Staply.
Shareholders clauses. How to avoid rookie mistakes with vesting?
Nobody wants to be in the situation, when yesterday you had, for example, 30% of the company and today you have only 0.03%. Especially, it becomes an issue, when the startup starts to grow rapidly or raises a big amount of money. In the beginning, in most cases, everything is done on the enthusiasm and strong belief of the founders that their startup will be a huge success. However, when founders face the rapid growth, everything unfortunately tends to change. If you want to build a great product and don’t want to waste time and money on lawsuits (Remember the case with Snapchat founders) there is something you should probably take care of before the phase of rapid growth starts in your company.
So, let’s discuss what is needed to be done. By this time, you already know how to designate the CEO and to agree on the responsibilities of each of the founders. (if not, read this article). Now it’s time to agree on vesting options and on how much shares each of the founders will have.
Generally speaking, “Vesting” is a tool that is made to motivate founders to work harder and to stay longer in the startup. As an example, imagine, that the CTO of the startup should have 30% of the company. Quite a standard practice is that he receives first part of his shares (for example 10%) only after 1 year of work, second part after 2 years of work (additional 10%, total 20%) and the last part (additional 10%, total 30%) after 3 years of being in the company. If CTO leaves the company before the agreed dates, he receives only a part of the shares or in some cases even nothing.
So, you need to discuss with the founders terms and conditions, upon which they will receive a new portion of shares. Terms and conditions can be different and there is no obligation to be bound to time periods. You can bind to KPI’s, achievements (like fundraising, sales, marketing). Also, in order to avoid “Zuckerberg’s case", you need to mention, that if investor or other 3rd party entity becomes a shareholder of the company, than the shares will be given from the founders in accordance with the previously agreed rules. Below I’ve shared (in Staply experience section) a very good statement, that you can use in your Vesting agreement, which will secure you from intentional and unintentional manipulations with shares.
Where can i find a template of the Vesting agreements?
Quite a good template of the vesting agreement you can find in docstoc using the following link: Vesting agreement.
Important thing to mention here is that founders should get shares of the company that will be a repository of the IP (Intellectual property). Reasons for that i will describe in one of the next articles.
Greg an me already agreed on the vesting and on how much shares each of us will have in the company. According to our agreement, he will own 70% of the company, since he generated the initial concept, I will own 30% of the shares of the company. Greg’s shares are described as follows:
“Gregory shall be a registered and beneficial owner of the amount of the Shares, which will be equal to 70% (seventy percent) of the capital Stock of the Company (“Gregory’s shares”), which is planned to be incorporated in the USA, state of California by the end of the year 2014.”
We are not incorporated yet, but we will be, if users like our product. Yes, we are fans of the lean startup concept.
Avoiding “Zuckerberg’s case”
The most important part is how the amount of shares will be spread among Founders and investor, when investor becomes a shareholder (Zuckerberg’s case). In our case, we agree that our shares (mine and Greg’s) will be decreased proportionally to the amount of shares, that the investor will get. So, for example, if investor gets 20% of the company, i will give 20% of my shares to the investor and Greg will give 20% of his shares to him. As a result, i will transfer 0.2*30=6% of the company, and Greg will transfer 0.2*70=14% of the company to the investor. In the end, I will have 30-6=24%, Greg will have 70-14=56% and investor will have 20% of the company. This part is described in our agreement as follows:
“In case one or more persons and/or one or more third parties (“Investor") are willing to buy a certain percentage of the capital Stock of the Company, Founders should transfer the same amount of percentage of their respective total amount of shares, which are planned to be issued with accordance to the terms and conditions of the Agreement, to the Investor.
For the avoidance of doubt, if, for example Investor purchases 20% (twenty percent) of the capital Stock of the Company, Founders transfer 20% (twenty percent) of their shares to the Investor - Dmitry transfers 0.2x30=6% of the capital Stock of the Company, Gregory transfers 0.2x70%=14% of the capital Stock of the Company. So, after shares are transferred, Dmitry’s total amount of shares would be equal to 30%-6%=24%, Gregory’s total amount of shares would be equal to 70%-14%=56%, Investor’s total amount of shares would be equal to 6%+14%=20%, wherein Dmitry and Gregory receive the shares with accordance to the Vesting, described in the present agreement, Investor receives the shares upon execution of the Investment agreement with the Company.”
By the way it is a good practice to use the last sentence in the agreements.
First of all we need to define, that all shares of the company are vested shares (just like, when you write a code, you need to define the type of variable (int, char, etc.). Here it is the same, but using “legal” language:
“Company considers it necessary and expedient in the interest of Company to request that Gregory agrees to 100% (one hundred percent) of the Gregory’s shares be subject to a vesting schedule (the “Vested Shares”).”
Special conditions for investors:
Typically investors don’t want to participate in vesting, since they often immediately or within a short period of time purchase a certain amount of shares of the company.
“In case one or more persons and/or one or more third parties (“Investor") are willing to buy a certain percentage of the capital Stock of the Company, the Investor shall receive all shares immediately, upon receiving investment on the bank account of the Company”.
In our agreement we established 3 year period, each year founder gets a one third (⅓) of the total amount of the shares, starting from the 2nd year.
“In the event that Gregory terminates his employment with Company or is terminated by Company:
- before the 1(first)-year anniversary of this Agreement, the Vested Shares shall be automatically forfeited and turned over to Company by Gregory and cancelled;
- before the 2(second)-year anniversary of this Agreement, but after the 1(first)-year anniversary of this Agreement, Gregory receives 34%(thirty four percent) of the Gregory’s shares; 66% (sixty six percent) of the Gregory’s shares shall be automatically forfeited and turned over to Company by Gregory and cancelled;
- before the 3(third)-year anniversary of this Agreement, but after the 2(second)-year anniversary of this Agreement, Gregory receives 66%(sixty six percent) of the Gregory’s shares, 34% (thirty four percent) of the Gregory’s shares shall be automatically forfeited and turned over to Company by Gregory and cancelled;
- After the 3(third)-year anniversary of this Agreement, Gregory receives 100%(hundred percent) of the Gregory’s shares.”
And the last thing that i want to mention in this article is how to have some additional protection from the Zuckerberg’s case. In our agreement we used the following statement:
“If one or more clauses, terms and conditions of the present Agreement have conflicts with one or more previously signed agreements and/or one or more agreements, that will be signed in the future, the terms and conditions of the present agreement should prevail.”
It basically says, that if someone tries to change vesting or terms of the shares transfer, it will not be valid, unless this agreement will be terminated, by signing a termination agreement by all the parties.
Before writing my next article, I will share with you my own Founders agreement and Vesting agreement templates and describe what each statement means line by line, so that you could understand why certain statements exist in the templates and what do they actually mean.
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