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Founder Shares

Founder estimating the value and dilution of his Founder Shares

Founder Shares are the initial shares issued to founders of a company around the time that the company is formed. These shares represent the equity interest of each founder in the startup and are often issued for a nominal cash payment and/or assignment of intellectual property.  Typically, founders purchase common stock for a nominal price, because, at formation, the company also presumably has little value.

Whether Founder Shares have any rights that differ from other equity interests in the company depends on the agreements between the founder and the company.

 

Characteristics of Founder Shares

 

  • Vesting: To protect the company's interests and incentivize long-term commitment, Founder Shares often come with a vesting schedule, which means founders earn their ownership in the business over time.  Under a typical vesting schedule, the shares vest in monthly or quarterly increments over four years; if the founder leaves the company before the stock is fully vested, the company has the right to buy back the unvested shares at the lower of cost or the then fair market value.

  • Cliff Period: There is often a one-year "cliff" before any shares vest. If a founder leaves before this period, they may not receive any shares.

  • Acceleration of Vesting:  Founder Shares may provide for accelerated vesting in certain circumstances.  A “single trigger” provision accelerates vesting of any unvested shares in the event of a sale of the company.  A “double trigger” provision accelerates vesting of any unvested shares if the company is sold and the employee is terminated without cause after the sale.

  • Right of First Refusal:  Under this provision the company and other founders or investors can purchase shares that a founder proposes to sell to a third party.  It is a useful mechanism for a company to control ownership of its stock.  Company bylaws also increasingly require Board approval for a transfer of stock.

  • Lock-up Agreement: In preparation for a future liquidity event, lock-up restrictions preventing the sale of stock for a period following an IPO are commonly included in founder stock purchase agreements.

  • Supervoting Rights:  Supervoting stock is a separate class of stock that may have 10 or more votes per share.  While founders are drawn to these shares for the enhanced protection against dilution and loss of control, investors object to it except in rare instances.  Typically, these shares convert to regular voting stock if transferred to a person other than the founder.

 

Founder Shares determine the initial distribution of equity among the founding team and should reflect the value each founder brings.  As the company grows, other forms of equity compensation (e.g. stock options) might be offered to new hires.  The initial Founder Share allocation can influence these decisions.  Investors also pay close attention to the distribution and vesting of Founder Shares – proper structuring can make a company more attractive to investors.

 

Financial Planning Considerations

 

  • Taxes: Founders may owe taxes on the value of their Founder Shares when they are granted, and they may also owe taxes on any realized gains at sale.  To minimize taxes as shares vest over time, U.S. founders might benefit from filing an 83(b) election with the IRS upon receiving shares.

  • Liquidity Events: Founders need to plan for events like acquisitions or an IPO.  How and when shares are sold can have significant financial and tax consequences.

  • Risk Management:  Founder shares are a risky investment.  There is no guarantee that the company will be successful, and founders may lose all or part of their investment.

  • Long-Term Value vs. Short-Term Needs: While Founder Shares have the potential to be life changing, they are not liquid assets until a liquidity event occurs.  Founders should plan their personal finances accordingly.

 

Conclusion

 

Founder Shares play a pivotal role in a startup's early journey. They can be a valuable tool for attracting and retaining top talent and for motivating founders to work hard and help the company succeed.  From a financial planning perspective, Founder Shares are highly risky investments that can be life changing if the company achieves high growth and value creation in the market.  Over the course of a startup’s journey from formation to a potential liquidity event several years into the future, founders can benefit immensely from thoughtful equity and estate planning that considers tax implications as well as overall financial and life goals.  

 

If you would like help finding a financial advisor with expertise in these areas, do not hesitate to reach out.  We are here to help you find a trusted financial advisor that is right for you.

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