February 22, 2024

February 28, 2024

Early vesting is broken!

At startups, too often, too much of the cap table is owned by individuals who left before things started to work, causing resentment amongst the ones who made it work. Early vesting needs rethinking.

pascal's notes

We just had a few founders in our portfolio raise their Series A and with it, many Series A leads insisted on founder vesting being reset to at least 50% of their stock being unvested. This is market standard.

From the Series A lead’s perspective, I fully understand that they want (co-) founders to continue to be incentivized / have to earn their share in the company. Plus it’s a hedge against a scenario where a big piece of the cap table is owned by individuals who are no longer with the startup.

Unfortunately, it happens too often that over time, too much the cap table is owned by people who left before things started to work. Not just founders.

I recently read this great post by Jared Hecht from USV where he thus argues that vesting for founders and early employees who own a meaningful part of the cap table needs rethinking:

Too many times I have seen founders who have slogged through nearly a decade of company building resent the fact that a big piece of their cap table sits with co-founders / early employees who departed the company before things really started working. […]

To hedge against this predictable outcome, more founders should adopt longer vesting cycles for themselves and the earliest (big equity) employees. Stretching things out to a six-year vest helps to prevent co-founder abandonment. Equally important, it also protects you if your co-founders aren't the right fit early on - you don't want someone leaving two years into building your company with the lion's share of the cap table. That sucks for everyone. Another construct I like is a four-year cycle where vesting is backloaded (e.g. 10% after year 1, 20% after year 2, 30% after year 3, and 40% after year 4). Longer vesting cycles also align founders with investors who are committing to the company and team. I recently learned of a firm asking founders to stretch out their vesting schedule for their unvested shares when leading a round. I like this, and while some founders may view this as unnecessary, it is a good thing. Incentive alignment is powerful.

Some people may argue that by starting or joining something very early stage they are assuming a lot of risk and therefore should receive a lot of the upside. The fact of the matter is that it usually takes many years for something to click, and by the time they normally do the teams that are in place can look quite different. Do people who were there early when things weren't working and subsequently left deserve meaningfully more than those who buckled down and willed the thing to product-market fit and scale? I don't think so. People should be rewarded for making something work, and that usually means being there for when it works. Being granted a meaningful amount of equity is not an entitlement, it is something that should be continuously earned over time. Stretching out the vesting schedule helps to level the playing field for the people there today, and for those to come in the future.

While it’s hard to get co-founders and early employees to agree to a non-standard (i.e. longer or backloaded) vesting schedule when they’re already taking a big risk on you by joining your unproven startup, it’s much harder to fix a broken cap table later on.

Co-founders / employees leaving before things start to work with them owning a meaningful part of the cap table, as Jared puts it, “happens more often than not - it’s the rule, not the exception.”

Thus, do the hard work upfront to set things up the right way. Even when it’s uncomfortable in the moment.

Until next week,

Pascal

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