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The article unfortunately contradicts itself. If a startup takes 10 years to build, why vest 25% of the shares after just one year? Then, it’s a very cost-effec

The article unfortunately contradicts itself. If a startup takes 10 years to build, why vest 25% of the shares after just one year? Then, it’s a very cost-effective strategy to leave after a year and let others work for you for the remaining 9 years. Article also presents a very outdated view: more equity means more motivation. According to two-factor theory [0], equity is not a motivation factor. [0] https://en.wikipedia.org/wiki/Two-factor_theory https://en.wikipedia.org/wiki/Two-factor_theory

robocat 4y ago
> why vest 25% of the shares after just one year? I don’t have any experience with the topic of vesting, but I will have a go at explaining how I see it. Investment risk reduces as the years go on. If you are ever investing your time, make sure you get an appropriate return for your risk. Ownership hardly matters if the company fails. Very complicated for poor company. However for a successful company, you as a founder presumably helped make it successful, so you deserve some ownership share (ownership matters the most when a business is very successful). You rightly point out that ownership amounts are contentious and they virtually always are because everything is a compromise with huge unknowns. I presume 4 years is just a rule of thumb for VC funded businesses - fast growth is expected and VC investments will dilute ownership and control. For a slower growth self-funded (bootstrapped) business, maybe more years is appropriate, but you definitely don’t want a zero-risk 10th year ownership percentage to be as valuable as the immense-risk first year. I personally would be more worried about “reverse dilution” provisions. Quote from a comment on the AVC blog: “Based on typical founder vesting provisions, if a founder leaves, [their] unvested shares are forfeited thereby effectively providing reverse dilution to the rest of the shareholders – including the investors who will now own x% + y%.” (not sure if this is true, the use of the word “forfeited” is poor because AFAIK shares are actually compulsorily bought back by the company). Example. Let’s say you have technical founder Zak (current job pays $200k), non-technical founder Bob (current job pays $200k), and angel investor Sue with $200k to invest. Business is to prove market in a year with a MVP, and then get VC funding to grow the business. They agree on a valuation of $1 million for their company, sign standard agreements that Zak and Bob vest over 4 years with a 1 year cliff. Cap table at founding is 40% Zak (common shares), 40% Bob (common shares) and 20% Sue (preferential shares). They use free cookie cutter legal founding documents from a website. Zak and Bob get paid $100k each for the first year by the business. At the end of year one, they get a VC round, $1 million for 25%. Cap table is now 25% VC (preferential), 15% Angel Sue (preferential), 30% Zak (common) and 30% Bob (common). Zak and Bob increase their salary to $200k. After another year Zak, Sue and the VC decide to kick Bob out (replacing with VC suggested CEO etcetera). The company buys back Bob’s unvested shares (15% of cap table) for 0.00001 cents per share (par value - total cost less than $1), and the company cancels the shares (not putting into treasury - not owning itself recursively!). There is no acceleration for Bob because it is not a sale or IPO. Cap table is now: 29.4% VC (preferential), 17.6% Angel Sue (preferential), 35.4% Zak (common), 17.6% Bob (common). Note that Bob’s ownership weirdly went up from 15% to 17.6% - maybe not obvious. Also note that before the one year cliff everyone had a huge financial incentive to sack Bob before Bob’s shares vested. Also note that Zak and Bob have invested $100k each (opportunity cost from having $100k less pretax salary in the first year), yet they only got common shares and not preferential shares. Their actual investment is around $70k each at post tax marginal rate, so they avoid some tax (depending on capital gains taxes etcetera). And investing “marginal dollars” because the first dollar one earns pays expenses, and the last dollar one earns is disposable income (assuming one can vary one’s income). The above is a very simple case. I would be interested to see proper write-up of actual situations and how circumstances played out in reality. Personally I think you want to spend as little time worrying about all the things that could go wrong, or how you could be shafted. You can’t protect yourself against the unlimited ways shit can fuck up. Choose founders and investors that have integrity. Choose founders and investors that have incentives to display integrity to others. Go with default agreements regardless of the obvious massive flaws and imbalances. Spend your time focusing on building a successful business. Excessive profit can prevent or resolve most problems.

robocat 4y ago

> why vest 25% of the shares after just one year? I don’t have any experience with the topic of vesting, but I will have a go at explaining how I see it. Investment risk reduces as the years go on. If you are ever investing your time, make sure you get an appropriate return for your risk. Ownership hardly matters if the company fails. Very complicated for poor company. However for a successful company, you as a founder presumably helped make it successful, so you deserve some ownership share (ownership matters the most when a business is very successful). You rightly point out that ownership amounts are contentious and they virtually always are because everything is a compromise with huge unknowns. I presume 4 years is just a rule of thumb for VC funded businesses - fast growth is expected and VC investments will dilute ownership and control. For a slower growth self-funded (bootstrapped) business, maybe more years is appropriate, but you definitely don’t want a zero-risk 10th year ownership percentage to be as valuable as the immense-risk first year. I personally would be more worried about “reverse dilution” provisions. Quote from a comment on the AVC blog: “Based on typical founder vesting provisions, if a founder leaves, [their] unvested shares are forfeited thereby effectively providing reverse dilution to the rest of the shareholders – including the investors who will now own x% + y%.” (not sure if this is true, the use of the word “forfeited” is poor because AFAIK shares are actually compulsorily bought back by the company). Example. Let’s say you have technical founder Zak (current job pays $200k), non-technical founder Bob (current job pays $200k), and angel investor Sue with $200k to invest. Business is to prove market in a year with a MVP, and then get VC funding to grow the business. They agree on a valuation of $1 million for their company, sign standard agreements that Zak and Bob vest over 4 years with a 1 year cliff. Cap table at founding is 40% Zak (common shares), 40% Bob (common shares) and 20% Sue (preferential shares). They use free cookie cutter legal founding documents from a website. Zak and Bob get paid $100k each for the first year by the business. At the end of year one, they get a VC round, $1 million for 25%. Cap table is now 25% VC (preferential), 15% Angel Sue (preferential), 30% Zak (common) and 30% Bob (common). Zak and Bob increase their salary to $200k. After another year Zak, Sue and the VC decide to kick Bob out (replacing with VC suggested CEO etcetera). The company buys back Bob’s unvested shares (15% of cap table) for 0.00001 cents per share (par value - total cost less than $1), and the company cancels the shares (not putting into treasury - not owning itself recursively!). There is no acceleration for Bob because it is not a sale or IPO. Cap table is now: 29.4% VC (preferential), 17.6% Angel Sue (preferential), 35.4% Zak (common), 17.6% Bob (common). Note that Bob’s ownership weirdly went up from 15% to 17.6% - maybe not obvious. Also note that before the one year cliff everyone had a huge financial incentive to sack Bob before Bob’s shares vested. Also note that Zak and Bob have invested $100k each (opportunity cost from having $100k less pretax salary in the first year), yet they only got common shares and not preferential shares. Their actual investment is around $70k each at post tax marginal rate, so they avoid some tax (depending on capital gains taxes etcetera). And investing “marginal dollars” because the first dollar one earns pays expenses, and the last dollar one earns is disposable income (assuming one can vary one’s income). The above is a very simple case. I would be interested to see proper write-up of actual situations and how circumstances played out in reality. Personally I think you want to spend as little time worrying about all the things that could go wrong, or how you could be shafted. You can’t protect yourself against the unlimited ways shit can fuck up. Choose founders and investors that have integrity. Choose founders and investors that have incentives to display integrity to others. Go with default agreements regardless of the obvious massive flaws and imbalances. Spend your time focusing on building a successful business. Excessive profit can prevent or resolve most problems.