We know there are two things that are certain in life: death and taxes. Although death is not a completely irrelevant topic in regards to vesting founders’ stock in your startup, taxes are more relevant at this point.

The default way that founders’ stock is treated by the IRS can lead to really bad tax consequences for the individual founders if a certain election is not made with the IRS at the time the initial stock grant is made. This election is called a Section 83(b) election. The effect of this election, when made, is that the IRS will treat the entire grant of stock as being complete at the time of the initial grant at the value of the stock at that time. The founder would realize income at that time, instead of the alternative, that being a taxable income event each time a portion of stock vests.

It’s a simple election, and it must be made within 30 days of the initial stock grant.

This concludes my five-part series on vesting schedules in a startup.

So what’s a standard vesting schedule for founders’ stock?

One standard vesting schedule is termed “Four Years with a One Year Cliff.”

Four Years is the total time period for vesting, and the “One Year Cliff” means that no stock will vest until one year has passed since the stock’s issuance to the founder. Because the one year cliff is 25% of the total vesting period, 25% of the founder’s stock will vest at that one year point. The rest will vest in equal amounts over the final three years, usually monthly at 1/48th of the total amount of stock.

Got it?

Oftentimes, vesting is accomplished through a Stock Repurchase Agreement within a corporation’s Shareholder Agreement. This gives the corporation the right to repurchase a founder’s stock at a particular price in the event that the founder leaves the company. Other times, there is simple language in a Shareholder Agreement that states that a certain percentage of the founder’s shares vest over a particular time schedule and that if the founder is terminated, the founder’s unvested (at that time) shares will return to unissued status.

In the next post in this series, I will discuss common time schedules used for vesting founders’ stock. Stay tuned.

What are some of the factors that you could use to allocate ownership among the founders?

Past Contribution

Future Contribution

Opportunity Cost

Relationships

There are no easy answers to these questions. The conversations can be VERY awkward. Get over it. Talk it out. Make decisions and put it to bed so you can get to work and build your business.

What is vesting? Vesting is the granting of full ownership rights in stock over time according to a schedule.

I’m going to discuss in depth the topic of vesting founders’ stock, but before I get too much into the nitty-gritty of what that is (in later posts), I feel it’s appropriate to outline why it’s important to implement a vesting schedule upon founders’ stock and how we should go about allocating that ownership in the first place.

Why is it important to vest founders’ stock?
Simply put, you need to vest founders’ stock because life happens, and at the time you start a business, you don’t have any idea what the future will bring. You don’t know if a fellow founder will drop out of the game for some reason, or even if YOU will need to leave the business after a few months or a year. It wouldn’t be equitable if someone owned a substantial percentage of the business without contributing his or her fair share of the work (if the work is what was earning the ownership, as opposed to strictly a capital contribution or intellectual property).

Sometimes people just don’t work out. Relationships amongst founders can deteriorate in a hurry. Vesting can make it easier for people to leave or be forced to leave without causing further trouble.

Which brings me to another point. When we’re vesting, we’re not only doing what is fair to the founders, we’re preventing potential disputes that can lead to litigation that could sabotage future business operations.

In Part 2 of this series, I’ll discuss factors that startups can use to decide how much equity each founder should receive.

The team that makes the fewest mistakes will win.

From start to finish, avoid making bad decisions. Seek wise counsel when necessary.

Play for and make the breaks and when one comes your way – SCORE.

Business is a series of opportunities. Seek them. When one appears, seize it!

If at first the game – or the breaks – go against you, don’t let up… put on more steam.

Make no mistake, business is hard. You will have trouble at times. The successful businessperson knows that adversity is always ready to strike and is willing to battle through the rough patches.

Protect our kickers, our quarterback, our lead and our ball game.

You invest time. You invest money. Don’t let it go to waste. Protect your business. Protect your assets, whether they are tangible, intangible, or human. Maybe you should think about hiring a lawyer. (wink wink, nudge nudge…)

Ball, oskie, cover, block, cut and slice, pursue and gang tackle… for this is the WINNING EDGE.

The business that can achieve greatness in the fundamentals over and over and over again is the business that will survive and thrive.

Press the kicking game. Here is where the breaks are made.

Although some football teams are “grind it out” types and some are “fun and gun,” all teams kick and punt. Similarly, businesses differ greatly in model and scope, but all must do one thing well – MARKETING. All other things being equal, the business that markets better will win.

Carry the fight to our opponent and keep it there for 60 minutes.

Although it is tempting to focus completely internally, the reality is that all businesses are part of a competitive marketplace. You’re in a battle against real opponents. Don’t forget it.

While a properly drafted non-compete agreement can protect your business, you need to know that the legal system places a very high premium on a person’s right to earn a living. If your agreement unreasonably restricts that right, it may be found invalid when enforcement attempts are made.

What are some of the key factors in creating an enforceable non-compete agreement?

Have a good reason

You need a good business reason for the agreement. You need a reason why that employee should not be allowed to work for a competing business, and that reason can’t be simply punishment for leaving your amazing business. Along with protection of trade secrets, protection of your customer base can serve as a solid business reason for the non-compete.

They’re not for everyone

Require the agreements only for those employees who have access to the critical information or those who are at a great risk for harming your business if allowed to compete with your company.

Be reasonable

Your agreement can’t be too great in scope, whether that scope is length of time, geographic area, or overbroad as to types of work that is prohibited.

To sum up, please know that these agreements can be critical to the success of your business. Your business should be protected and must be protected to the fullest extent. However, do not go too far in attempting to do so. Be smart about it and don’t be unreasonable. You may do more harm than good in the long run.

1. Hiring an employee is going to cost you more. Employment taxes and benefits are the main cause of this.
2. Independent contractors are more flexible in terms of their ongoing relationship to you.
3. Exposure to litigation-type liability is reduced with an independent contractor; increased with an employee.
4. You have more control over the work of the employees.
5. Consistency is a factor with the work product of an employee. You are more likely to need the services of multiple contractors, rather than one employee.
6. Intellectual property will most likely automatically be the property of the employer when created by the employee in the course of his or her job. When created by an independent contractor, great care must be taken to ensure that intellectual property is properly transferred to the business. You should always have an agreement outlining such matters.

There are advantages and disadvantages to both approaches. The most important thing is that you don’t enter into either relationship as an uninformed business owner.

Angel investors sometimes form groups in order to more completely screen and evaluate investment opportunities.

Angel investors typically receive preferred stock for their investment, but occasionally invest in convertible debt.

A Member performs similar functions of a shareholder of a corporation – entrusting the management of the LLC to the managers, if any (like the shareholders of a corporation entrust management to the directors and officers of the corporation).

Members must also participate in major decisions like a merger or liquidation of the LLC, an amendment of the Articles of Organization or Operating Agreement, and matters regarding windup and dissolution of the LLC entity. Further responsibilities of the Members are often designated in the LLC’s Operating Agreement.