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Reverse Vesting
Reverse vesting occurs when a company’s co-founder receives his or her shares and ownership interest upfront. This exchange is subject to vesting similar to employee stock options. When founders launch a start-up, they immediately get equity. Reverse vesting ensures that if a founder leaves the company before the specified period is over (usually four years), the company can purchase its share of equity for little to no cost.
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Why Reverse vesting is important for start-ups?
Protects Company
The purpose of reverse vesting is clear. It ties founders to their start-ups and protects the company, co-founders, and investors. If founders were to leave and take their portion of shares with them, the start-up could quickly tank. It could also prevent the company from attracting future investors.
Founder Commitment
A reverse vesting agreement motivates founder commitment. Founders know that the only way to hold on to their shares is to continue with the company for four years.
Real interest in the Company’s success
Not all start-ups last four years, but a founder who is invested in the company will work hard to ensure its success. A founder who leaves after four years can still hold on to his shares, which means that the success of the company is in everybody’s best interest.
Keeps ownership within the company
Without a reverse vesting agreement, a founder who owns the majority of shares and leaves would essentially dismantle the start-up. With a reverse vesting agreement, however, a founder can leave and the majority of equity would revert back to the company, thus protecting other investors and employees
Tax Benefits
With reverse vesting, the founder doesn’t take ownership of the shares until the waiting period is over. This reduces the tax burden on the founder, since the shares are acquired at a later date. It also means that the founder’s worth can go up as the shares of the start-up increase in value
Protects investors
Investors are attracted to strong leadership as much as they are to specific products. A reverse vesting agreement increases the likelihood that a founder will stay with the company, which is what investors want.
How reverse vesting works?
Any person who would like to avail the following advantages may opt for this form of structure
- A founder must agree to reverse vesting. When they do, either some or all of their shares are subject to reverse vesting.
- The standard ratio is 75 percent, meaning a founder keeps 25 percent ownership. The other 75 percent reverse vests over time with one exception. If a founder has run the company for an extended period, he or she may reverse vest more quickly.
- The founder of a start-up will generally reverse vest his or her ownership interest over a period of two to three years. When the owner reaches a milestone, such as six months or a year, he or she gains possession of a portion of the stock.
- For an owner with 75 percent reverse vested over a three-year span, he or she will work on a schedule where the owner earns back 25 percent of the ownership stake each year. Some agreements are monthly or quarterly instead. In those situations, the founder would regain a little more than 2 percent of his or her stock for each month the founder stays at the company.
Documents required for Reverse Vesting
Balance sheet and Profit & Loss Account
Board’s Report
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How Taxified Can Help You?
- Drafting of Reverse Vesting Agreement
- Assistance on valuation.
- Any other service required to facilitate smooth execution of aforesaid.