Explained! Founder Lock-in and Vesting of Founder Shares.

What does Founder Lock-in and Vesting mean?

Founder lock-in means that the Founder(s) shall not be entitled to transfer their shares to any other person prior to expiry of the lock-in period mentioned in the shareholders’ agreement.

Founder share vesting means that the investor prohibits the economic rights of the shares held by the Founder and imposes a condition that the rights of the shares held by the Founder shall vest to him over a certain period of time, which is usually equal to the lock-in period.

How are these conditions imposed?

A. Founder Lock-in

Upon signing of the shareholders’ agreement, the Founder would be prohibited to sell the shares for a specified period (typically, 3 – 4 years but can be longer). This enables the investors to ensure that the Founder (the originator of the business and idea) stays with the company for a specified period of time. Given that this is a contractual obligation, the restriction will remain unless specifically agreed with the investors.

B. Founder share vesting

This is similar to vesting conditions imposed under an ESOP scheme. Assuming, the Founder holds 100 shares in the company, illustratively, the vesting conditions could provide for vesting of shares in the following sequence:

  • First 33.33% shall vest upon signing of the shareholders’ agreement
  • Next 33.33% shall vest upon completion of 1 year from the date of signing
  • Last 33.33% shall vest upon completion of 2 years from the date of signing

As a result, the economic right of the Founder in the company would be restricted only to 33.33% of his shares for the first year.  However, such restriction does not apply on voting powers.

Founder’s exit during vesting

Although, the Founder is not permitted to transfer the shares in the company to a third-party during the lock-in period, the agreement may provide flexibility for exit by the Founder during the vesting period.

Where the exit is amicable, the investor may agree that either the company or the investor can buyout the shares held by the Founder.  Usually, in such situations, the Founder is paid the fair consideration for the entire shares held by him (vested or unvested).

Where the exit is because of a dispute, the investor may agree, either directly or through the company, to buyout the Founder. In such circumstances, the investor may agree to pay fair consideration only for the vested shares and buyout the unvested shares for nominal consideration. 

This post is part of our Founder’s handbook – “Negotiating Shareholder’s Agreement”, a comprehensive handbook for founders to negotiate shareholder’s agreement. Click here to download the complete handbook.

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