Editor’s note: Investor and entrepreneur David Gardner is the founder of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire.
CARY – For my next few articles I hope to focus on some of the most misunderstood terms the entrepreneurs find in a typical venture capital terms sheet.
Of all of the terms that have to be negotiated in an investment terms sheet few seem as unfair to founders as being asked to have some of their equity vest over time in their own company. Entrepreneurs push back more on this term then almost any other. They argue, “We started this company and it was our idea…why should we now give up equity in order to have that equity slowly vest again over the next few years?”
Over time, a venture capitalist gets to see every possible scenario play out so like most venture funds, Cofounders Capital requires some level of founders’ vesting as a condition for our investment. We do this for several reasons and believe that it is something that savvy founders should want as well.
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Founder vesting provides a pre-agreed way for cofounders to leave their company if they choose. Although we have never had founders fall out with us, we have often seen them fall out with each other. One cofounder might get tired of working seventy-five hours a week or get a dream job offer that he or she just can’t turn down. Sometimes, one of the founders does not have the skills or temperament to stay in a senior management role as the company grows and gets upset when cofounders come to realize this and ask him to be subordinate to a non-founder.
Regardless of the reasons, founders should be able to leave their company if they choose. When this happens, it can then be very unfair to the remaining founders who may continue working long hours at submarket salaries for years longer but have only the same equity as the departing founder. Equity is granted for money or sweat so if some cofounders are going to be “sweating” more than others then it seems fair to me that they should have proportionately more equity. There needs to be an agreement in place for a cofounder to leave the company that is fair to both the departing founder and his or her remaining cofounders.
Like most people, founders are very agreeable when it comes to theoretical money but once the dollars become bigger or feelings have been hurt their sense of what if fair and reasonable often becomes clouded. This is why, while all founders are still friends and agreeable, we ask them to decide on appropriate founder vesting. Once in place, a founder can leave at any point and his or her unvested shares will go back into the company. This can be used as part of an option pool to reup the remaining founders or to recruit new talent that will be doing the job the departing founder had been doing. This is perceived as fair because it is time-weighted and all founders agreed to the same terms from day one of venture backing.
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There are other reasons why we insist on some founder equity vesting. Of the many data points to be considered when investing none is more weighted than the commitment and caliber of the founders. I often say that we invest in people not ideas. If we were not very impressed with the founding team then we would not be investing. In general, I just like to see how strongly and why some entrepreneurs push back on founder vesting. I ask, “You said that you plan to be here for the next few years and see this thing through to an exit, so why is this term an issue?” This discussion is good to have because it often reveals things even the cofounders did not know about each other and their level of commitment to the venture.
I had a cofounder ask me recently, after the premature departure of a cofounder, why I had not pushed her harder to require more of their equity to vest over a longer period. I reminded her that longer vesting was what we originally requested but compromised on when she pushed back on the term. Founder vesting is a common term because it protects both the investor and the cofounders.
There is an old Chinese curse that says, “May you get what you want.” When it comes to founder vesting, getting what founders think they want can indeed end up leading to regret.
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