Vesting restrictions on shares held by the founders
Accelerating vesting on a sale or termination
Vesting terms that make sense
Tax implications related to shares that vest
Difference between options and restricted stock
Tax differences between ISOs and NSOs
Granting options vs. issuing restricted stock
Advisory board setup and compensation
Reserving shares under the company's option plan
Vesting restrictions on shares held by the founders
Founders should put vesting restrictions on their shares. "Vesting" means that you need to "earn" your shares before you are allowed to keep them if you leave the company. Investors will insist that the founders' shares are subject to vesting, because it is important that the team they are investing in is motivated to stay with, and build value in, the company. As founders, you should want vesting restrictions imposed on each other's shares as well. Otherwise, one founder could just leave the company and keep his or her shares while the other founders are the ones working hard to build value in the business.
Accelerating vesting on a sale or termination
You may want the vesting of your shares to accelerate if you are fired or the company is sold. Is that a good idea? Will your investors agree to this?
Vesting terms that make sense
Equity is often the primary financial motivation for taking risk in a new venture. To be a proper incentive, the reward of equity should be tied to each person's contribution to the success of the venture. In an ideal world this would mean milestone-based vesting over several years. However, the reality is that few startups can predict what milestones will be most important beyond a few months in advance with any accuracy, and therefore most equity award vesting is time-based. Shares held by founders typically vest over a four- to five-year period on a monthly or quarterly basis. Most non-founder employees vest over a four- to five-year period with a one year cliff (25% vests after the first year) and monthly or quarterly vesting thereafter for the remaining three or four years. The cliff period gives the company time to determine whether the employee is working out before the person gets to keep any of his or her shares. Sometimes founders' shares do not have a cliff.
Tax implications related to shares that vest
If your shares are subject to vesting, how and when you are taxed on those "restricted shares" is governed by Section 83 of the Internal Revenue Code. Specifically, the tax consequences depend upon whether you make an election—known as a "Section 83(b) election"—under Section 83 or not.
Difference between options and restricted stock
"Restricted Stock" is a term often used to refer to shares of stock of a company that are subject to vesting requirements. The shares are purchased and owned by the shareholder. The shareholder can vote the shares. If a dividend is paid on the shares, the shareholder is entitled to be paid the dividend. However, the shares are subject to vesting. However, if the shareholder ceases providing services to the company—as an employee, consultant, advisor or otherwise—the company has the right to get back any of the shares that were not then vested (typically be paying the shareholder back the original purchase price paid for the shares). With time-based vesting, this means that the percentage of the shares that the company has the right to purchase decreases over time. This is sometimes referred to as "reverse vesting" in order to describe the contrast with vesting of options where the number of shares the option holder is entitled to purchase increases over time/as they vest.
Tax differences between ISOs and NSOs
In the US, there are two types of compensatory stock options: incentive stock options (often called ISOs) and non-qualified stock options (often called NSOs). Companies can grant ISOs or NSOs to their employees. However, they cannot grant ISOs to non-employees. Therefore, options granted to contractors/consultants, advisors and non-employee directors - can only be NSOs. Other requirements of ISOs include:
Granting options vs. issuing restricted stock
Restricted stock is almost always issued to founders when the company is formed. Most early stage companies prefer to limit the number of shareholders who have the right to vote and therefore tend to instead grant options to non-founders. Also, because recipients of restricted stock must pay the fair market value of the stock up-front (as opposed to options where they wait to pay for the shares until they exercise the option) it becomes more and more expensive to purchase restricted stock as the company increases in value. As a result, most private companies will instead grant options to non-founder employees, consultants, advisors and directors.
Advisory board setup and compensation
Advisory boards can be useful things—especially in the earliest phases of your startup. They are often luminaries, academics and industry experts, and having people like that who are willing to make themselves available to answer questions, provide you with insights, perspective and feedback or to merely lend some credibility to your venture can be very valuable. Calling it a "board" is a bit of a misnomer, because advisory boards rarely actually meet as a group. The amount of time they contribute is often quite limited, and they aren't generally tasked with a specific project or deliverable like a consultant would be.
Reserving shares under the company's option plan
The option "pool" represents the number of shares the company sets aside in reserve under its option plan to compensate its employees, consultants, advisors and directors. The size of the option pool depends on the company's stage, circumstances and hiring needs. When the company issues shares under the plan, it dilutes the ownership percentage of the other shareholders proportionately. However, any shares reserved under the plan that are not used (i.e., that are not sold or issued by the company) do not dilute the actual ownership of the other shareholders. Therefore, the size of the option pool at the initial formation of the company doesn't really matter all that much—if the pool is too small and you need more shares, it can always be increased; if the pool is larger than you actually need, any excess shares don't have any negative impact on the actual ownership of the company. Most startups will initially reserve an option pool that is big enough to provide for the equity incentives needed to cover their anticipated hiring needs for the first six months to a year.
- The right time to incorporate
- Determining the right type of entity to create
- Where to incorporate
- Defining “qualified to do business” and where to be qualified
- Who makes decisions for the company?
- How startups compensate employees
- Foreign employees and their need for a visa
- Who owns your IP
- Licensing IP from a university or hospital
- Retaining a license to your IP
- Non-competes with former employers
- Reserving shares under the company’s option plan
- Allocating equity among founders
- Vesting restrictions on shares held by the founders
- Vesting terms that make sense
- Accelerating vesting on a sale or termination
- Tax implications related to shares that vest
- Rules for foreign founders in the US on a student visa
- Who owns your IP
- Non-competes with former employers
- Take a good idea with you when you leave a company
- Retaining a license to your IP
- Founder compensation
- Founder employment agreements
- Accelerating vesting on a sale or termination
- Vesting terms that make sense
- Tax implications related to shares that vest
- Difference between consultants and employees
- How startups compensate employees
- Foreign employees and their need for a visa
- Unpaid interns
- Non-competes with former employers
- Reserving shares under the company’s option plan
- Agreements with employees
- Hiring a team before securing funding
