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.’”
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.
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:
- 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.
“Cause” shall mean the occurrence of:
- 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),
- 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
- 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.
“Good Reason” shall be deemed to occur if: