Found+READ: Stories by Babak Nivi

Vesting Hacks: Part I

Babak Nivi, Naval Ravikant — Thu, 19 Apr 2007 18:31:22 GMT

This is the first in a series of Venture Hacks articles on how to get the most out of your founder's equity.

"By the time we did the financing we had been working on [the company for] 2 years, but they only vested us a year. So, they got a year of free vesting from us."

– Joe Kraus, Founders at Work

Summary: Don't agree to vest all of your shares just because it is supposedly "standard". Get vested for time served building the business.

Your Series A investors will ask you to give all your founder's shares back to the company and earn your shares back over four years. This is called vesting — see Brad Feld's article on vesting if you need a primer. Vesting is a good idea:

You are critical to the company and you have told your investors that you are committed to the business. They are simply asking you to put your shares where your mouth is: a vesting schedule demonstrates your commitment to the company.
Vesting also ensures that a co-founder who leaves the company early doesn't receive the same amount of equity as co-founders who stay in the business.

Get vested for time served building the business. But don't agree to vest all of your shares just because it is supposedly "standard".

If you have been working on the company full-time for one year, 25% of your shares should be vested up-front and the balance of your shares should vest over three to four years. The best vesting agreement we have seen for a founder in a Series A is 25% of shares vested up-front with the balance vesting over three years. You should argue that,

“New employees who join the company today will earn all their shares over four years. Employees who are already here should be credited for their time served.”

We don't recommend trying to escape a four-year commitment to the company (including time served). Four years is the typical commitment for a start up, high school, or college, as well as the span between Olympics and World Cups, and the term we give our Presidents to start as many wars as possible. Consider cliffs for newfound co-founders. One-year cliffs are typical for employees but currently rare for founders. Nevertheless, consider negotiating one-year cliffs with newfound co-founders whom you haven’t worked with in the past. If a co-founder leaves the company after three months, you don't want him walking out the door with a large chunk of the company. Note: See the rest of the venture hacks. Thanks go to Mark Fletcher for reviewing this hack. This is not legal advice.

Vesting Hacks: Part II

Babak Nivi, Naval Ravikant — Fri, 20 Apr 2007 15:28:58 GMT

This is the second in a series of Venture Hacks articles on how to get the most out of your founder's equity.

“During the whole funding process they said, ‘We're interested in you guys because of your management team; we think you're fantastic...’ Two weeks later they pull me into the office – before even the first board meeting – and say, ‘We want to replace you as CEO.’”

– Mark Fletcher, Founders at Work

Summary: You made a commitment to the company by agreeing to a vesting schedule — the company should reciprocate and commit to you by granting acceleration upon termination.

Over time, your continuing contributions to the company will become relatively less important to its success. But the number of shares you vest every month will stay relatively large. Founders generally make their greatest contributions at the early stages of the business but their vesting is spread evenly over three to four years. As your relative contribution to the company diminishes, everyone at the company has an incentive to terminate you and benefit ratably from the cancellation of your unvested shares. Nevertheless, in our experience, founders are allowed to vest in peace unless they are incompetent, actively harmful to the business, or clash with a new CEO. You will probably be terminated if you clash with a new CEO. By definition, a new CEO is hired to change the way things are and provide new leadership to the business. That he might clash with founders who previously ran the business is predictable. Naturally, the CEO usually wins any disagreements or power struggles. He is the decider and he decides what is best. The investors, board, and management will almost certainly agree to fire your ass if you continuously clash with a new CEO and you will lose your unvested shares.

Accelerate your shares if you are terminated. 50% to 100% of your unvested shares should accelerate if you are terminated without cause or you resign for good reason. Cause typically includes willful misconduct, gross negligence, fraudulent conduct, and breaches of agreements with the company. 'Clashing with the new CEO' is not cause. Good reason typically includes a change in position, a reduction in salary or benefits, or a move to distant location. Detailed definitions are included in the Appendix below. Make sure you receive this acceleration whether or not your termination or resignation is in connection with a change in control of the company, such as a sale of the business. You can clash with your acquirer too. Justify acceleration by appealing to reciprocity. Acceleration upon termination may cause consternation among your investors but it is easy to justify:

"A founder’s most important contributions generally occur in the early stages of a business but he earns his shares evenly over time. If I clash with a new CEO and he terminates me, I should receive the equity I earned with those contributions.” The founders agreed to a vesting schedule to demonstrate our long-term commitment to the business. You have told us that the founders are critical to the company — that we are the DNA of the business. Acceleration demonstrates the company’s long-term commitment to our continuing contribution."

This argument is an application of the reciprocity norm which requires your opponent to be fair to you if you are fair to him. Your vesting schedule locked you into a commitment to the company — that was fair — now acceleration locks the company into a commitment to you.

It is even easy to justify 100% acceleration if you are the sole founder of the business:

"Right now, I own 100% of my shares. After the financing, I will have to earn these shares back over the next four years — I've agreed to that. But if I’m removed from the business, I lose the right to earn my shares back. If that happens, I should walk out the door with the shares I came in with."

Avoid unfair termination with a democratic board. As usual, the best way to avoid unfair termination and avoid hiring a bad CEO is to create a board that reflects the ownership of the company with hacks like making a new board seat for a new CEO. Acceleration for co-founders can do more harm than good. If you have a team of founders, acceleration upon termination can do more harm than good. A co-founder with acceleration upon termination who wants to leave the company can misbehave and engender his termination. If the company decides to terminate him without cause to avoid possible lawsuits, your co-founder will walk away with a lot of shares. In California, it is actually very difficult to prove cause unless an employee engages in criminal activity. If you trust your co-founders absolutely, you should negotiate as much acceleration upon termination as you can. Otherwise, you need to decide which is worse: the expected value of misbehaving co-founders who leave with a lot of shares or the expected value of leaving a lot of shares behind after your termination. Appendix: Definitions of 'Cause' and 'Good reason'. Your lawyers will help you define cause and good reason. Definitions that we have used in the past follow. Note that the definition of good reason below assumes the company plans on hiring a new CEO at some point:

"Cause" shall mean the occurrence of:

The willful misconduct or gross negligence in performance of his duties, including his refusal to comply in any material respect with the legal directives of the Company’s Board of Directors so long as such directives are not inconsistent with a party’s position and duties, and such refusal to comply is not remedied within ten (10) working days after written notice from the Company, which written notice shall state that failure to remedy such conduct may result in termination for Cause;
dishonest or fraudulent conduct, a deliberate attempt to do an injury to the Company or the conviction of a felony; or
breach of the Proprietary Information and Inventions Assignment Agreement entered into with the Company.

"Good Reason" shall be deemed to occur if:

1. there is a material adverse change in employee’s position of employment causing such position to be of materially less stature or of materially less responsibility, including without limitation, a change of title or responsibilities normally associated with such title, without employee’s consent (other than, with respect to the Founder(s), a change, in connection with the appointment of a new CEO, to an executive officer level position with normally associated responsibilities that reports directly to the CEO or the Board of Directors),
2. there is a reduction of more than ten percent (10%) of employee’s base compensation unless in connection with similar decreases of other similarly situated employees of the Company, or
3. employee refuses to relocate to a facility or location more than sixty (60) miles from such employee’s principal work site; and
within the one (1) year period immediately following such event the employee elects to terminate voluntarily his employment relationship with the Company.

Note: See the rest of the venture hacks. This is not legal advice.

Vesting Hacks: Part 3

Babak Nivi, Naval Ravikant — Wed, 25 Apr 2007 15:28:22 GMT

This is the third in a series of Venture Hacks articles on how to get the most out of your founder's equity.

"We talked to a lot of different angel investors and venture capitalists, but no one really 'got' what we were doing — that is until we met Google."

– Dennis Crowley, Founder of Dodgeball, May 2005

"It's no real secret that Google wasn't supporting dodgeball the way we expected. The whole experience was incredibly frustrating for us — especially as we couldn't convince them that dodgeball was worth engineering resources, leaving us to watch as other startups got to innovate in the mobile + social space… It was a tough decision to walk away…"

– Dennis Crowley, Founder of Dodgeball, April 2007

Summary: Negotiate some acceleration if you sell the company ahead of schedule — you don't want to stay at the acquirer for an unreasonable period of time. Also negotiate 100% acceleration if the acquirer terminates you and deprives you of the ability to vest your stock.

Your vesting should accelerate upon a change in control of the company, such as a sale of the business. Negotiate both single and double trigger acceleration. Your options for acceleration upon a change in control, from best to worst, include

Single trigger acceleration which means 25% to 100% of your unvested stock vests immediately upon a change in control. Single trigger acceleration does not reduce the length of your vesting period. It only increases your vested shares (and decreases your unvested shares by the same amount).
Double trigger acceleration which means 25% to 100% of your unvested stock vests immediately if you are fired by the acquirer (termination without cause) or you quit because the acquirer wants you to move to Afghanistan (resignation for good reason). The hack for acceleration upon termination already provides double trigger acceleration and provides sample definitions of termination without cause and resignation for good reason.
Zero acceleration which is a little better than getting shot in the head by the Terminator:

The most common acceleration agreement these days combines 25% - 50% single trigger acceleration with 50% - 100% double trigger acceleration. The median of this range is probably 50% single trigger combined with 100% double trigger. Justifying single trigger acceleration. You can justify single trigger acceleration by arguing that,

"We didn't start this company so we could work at BigCo X for two or three years. We're entrepreneurs, not employees. We're willing to work at BigCo, but not for that long.
If we sell the company after two years, that just means we did what we were supposed to do, but we did it faster than we were supposed to. The investors will be rewarded for an early sale by receiving their profits earlier than they expected. We shouldn't be penalized for an early sale by having to work at BigCo for years to earn our unvested shares.
Single trigger acceleration reduces the effective time we have to work at BigCo and rewards us for creating profit for the investors ahead of schedule."

Justifying double trigger acceleration. You can justify 100% double trigger acceleration by arguing that,

"The aim of vesting is to make me stick around and create value — not to put me in a situation where I am deprived of the opportunity to vest because I am terminated for reasons beyond my control or I resign because the environment is intolerable.
So, if I am terminated with no cause by the acquirer, I should vest all my stock. Or if the conditions at the acquirer are intolerable and I resign for good reason, I should vest all my stock."

The risk of termination at an acquirer is much greater than the risk of termination in a startup. Investors are generally investing in the future value of a startup — they're investing in people. Acquirers are generally investing in the existing value in a startup — they're investing in assets. Acceleration agreements give you leverage upon a sale. When you sell a company, the acquirer, founders, management, and investors will renegotiate the distribution of the chips on the table. It isn't unusual to renegotiate existing agreements whenever one party has a lot of leverage over the others. To quote the fictional Al Swearengen,

"Bidding’s open always on everyone."

Negotiating your acceleration agreement now gives you leverage in this upcoming multi-way negotiation.

If an acquirer doesn’t like your acceleration agreement, they can decrease the purchase price and use the savings to retain you with golden handcuffs. A lower purchase price means less money for your investors. This provides you with negative leverage against your investors — you can decrease your investor's profit if you refuse to renegotiate your acceleration.
Or, the acquirer can increase the purchase price in return for reducing your acceleration. A higher purchase price means more money for your investors. This provides you with positive leverage against your investors — you can increase your investor's profit if you agree to renegotiate your acceleration.

Visible contributors benefit the most from the renegotiation. After this renegotiation, the CEO and key members of the management team often end up with better acceleration agreements than everybody else. That’s not a big surprise — the CEO is leading the renegotiation. Founders who are perceived as major contributors by the board and acquiror may also benefit from the negotiation. If you’re the Director of Engineering, you’re probably invisible to the acquirer — if you’re the VP of Engineering and involved in the negotiations, you may do much better. As always, the best defense against these shenanigans is to create a board that reflects the ownership of the company and to make a new board seat for a new CEO. Appendix: Definition of 'Change in Control' A sale of the company is an example of a change in control. Your lawyers will help you define change in control. A definition that we have used in one term sheet follows.

"Change in control"

Note: See the rest of the venture hacks. This is not legal advice.

Vesting Hacks: Part 4

Babak Nivi, Naval Ravikant — Fri, 27 Apr 2007 15:19:27 GMT

This is the fourth and final article in a series of Venture Hacks on how to get the most out of your founder's equity. Our previous vesting hacks have discussed getting vested for time served, acceleration upon termination, and acceleration upon a sale. In conclusion, we offer a few "microhacks" for leveraging your vesting plan in various termination situations. 1. Reclaim a terminated co-founder's unvested shares. A terminated co-founder's unvested shares are typically cancelled. The resulting reverse dilution benefits the founders, employees, and investors ratably. Instead of canceling the shares, divide them among the remaining co-founders and employees ratably. You should argue that,

"Cancelling a terminated co-founders shares puts a lot of pre-money into the investor's pocket. Those shares should be distributed among the founders and employees who created that pre-money valuation."

This argument will carry more water if you offer to put a portion of the reclaimed shares into the option pool to hire a replacement for the co-founder. Reclaiming a terminated co-founder’s shares does not create an incentive for co-founders to terminate each other. Co-founders have an incentive to terminate each other even if the shares are cancelled. In our experience, this incentive is never a factor. Founders are almost always allowed to vest in peace unless they are incompetent, actively harmful, or clash with a new CEO. 2. Run screaming from the right to purchase vested stock. Some option plans provide the company the right to repurchase your vested stock upon your departure. The purchase price is 'fair market value'. Guess whether the definition of fair market value is favorable to you or the company…

Founders and employees should not agree to this provision under any circumstances. Read your option plan carefully. 3. Accelerate your vesting upon hiring a new CEO. If you are having trouble applying any of the other vesting hacks, trade those chips in for six months of acceleration upon hiring a new CEO. Investors are usually eager to bring in "professional" management. They should agree to this term because it aligns your interests with theirs. 4. Keep vesting as a consultant or board member. If you have a lot of leverage, you may be able to negotiate an agreement to keep vesting if you are terminated but retained as a consultant or a board member. For example, the company may terminate you but keep you as a consultant to help decipher your spaghetti code. Some companies have been known to sneak this term into their closing documents. We’re not big fans of that approach. Again, if you are having trouble applying any of the other vesting hacks, you may be able to trade those chips in for this one. Note: See the rest of the venture hacks. This is not legal advice.