Issuing Restricted Stock to Founders
One of the common questions we hear from startups is whether the stock issued to the founders should be restricted. There are some important issues to consider when deciding whether to create a vesting schedule for founders. Today’s post highlights some of these issues and the main reasons for issuing restricted stock.
What is restricted stock?
First things first, let’s explore what exactly restricted stock is. Restricted stock is stock that is subject to forfeiture to the company, either for compensation or for no additional compensation. Restricted stock is generally subject to forfeiture until the stock “vests” (see below for a discussion of vesting). For example, an early stage company may issue stock to its founders, but the founders are only entitled to the stock if they continue to work for the company for a specified period of time. The shares will “vest” according to the vesting schedule. Once the stock is vested, it is no longer subject to forfeiture.
What is a vesting schedule?
Typically the company will create a vesting schedule that states exactly how many shares will vest and when. For example, the founders may receive 100 shares of ABC Company. Each founder will receive 25 shares when the company is formed, 25 shares after one year, and the remaining shares over the course of the following two years. Under this three-year vesting schedule, the founders are required to stay with the company for at least three years in order to receive all 100 shares. If one founder leaves after two weeks with the company, he is only vested in 25 shares and he will forfeit the remaining 75 shares.
Why issue restricted stock to founders?
The main purpose of issuing restricted stock to founders is to make sure that the founders stay with the company during its early years. For many companies, there is a ton of value tied up with the key employees of the company. Providing incentive for founders and key employees to stay with the company is extremely important for startups.
If you include a buy-back right with the restricted stock, it allows the company the ability to re-purchase shares from a founder that loses interest in the company and fails to contribute to its development.
If you’re an early stage company that is looking to raise capital from investors, the investors will want to make sure that key employees (including founders) stay with the company. One simple way to ease investors’ apprehensions is to issue restricted stock to founders.
There are also tax advantages to issuing restricted stock to founders. We always advise consulting your CPA to discuss the consequences of restricted stock and making an 83(b) election with the IRS.
Also, we always recommend consulting a business attorney who is well-versed in securities regulations when issuing company stock.
If you’d like to learn more about restricted stock or issuing equity to founders, please feel free to contact us to schedule your free consultation.