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Startups Entering the U.S. Market 101 (3) – Vesting (ENG)
Conditional Incomplete Stock Grant (Vesting)
Startups can issue outright stocks that can be exercised immediately, but they can also issue stocks on a vesting condition. Grantees of the outright stocks take a full ownership on the day they are granted and there is no risk of losing their stocks in the future. However, the grantees of the stocks on a vesting condition may have to forfeit their stocks or the company may repurchase their stocks if certain conditions are not met.
Startup founders ideally want to receive the outright stocks of the company they own. If they work unpaid for the company, they feel even more reluctant to receive stocks on a vesting condition. However, startup founders need to understand that issuing stocks on a vesting condition from the initial issuance of stock may be in the best interest of both the company and the founders themselves.
First, there may be members who suddenly depart the company after receiving outright stocks without completing the role they initially promised. There is no guarantee that the startup founders’ unity will last forever. Often times, there might be a serious conflict between the founders over how they operate the company, and they may want to go their separate ways. Especially if the company performs poorly with no profits generating and no investments being made, some of the founders may want to relocate to a job that will pay them immediately. Furthermore, there is no guarantee that conflicts and divisions among the founders will not happen in the early stage of business, perhaps just one day after the stocks are issued. As a result, granting a full ownership of stocks after a certain period of time following the stock issuance (after the founders have completed some of their respective roles and tasks promised in exchange for stocks) is a way to minimize further conflicts.
Second, if the situations mentioned above do occur, the company needs to seek a replacement for a member leaving the company. In such cases, if the company reissue stocks and grant it to the new member, the stocks of the founding members may be diluted. In other words, if a founding member of the company suddenly leaves the company after receiving a full stock, the remaining members will not only struggle to complete the incomplete tasks, but the value of their stocks will be lowered, and it causes an unfair consequence.
Finally, investors prefer companies that issued stocks on a vesting condition. Many VCs cannot help but to take into consideration the startup founders’ skills, ability, and commitment to the company when selecting companies to invest in. They obviously seek to invest in a startup with founders who have strong motivations for success rather than a startup with founders who already have outright stocks and can leave the company whenever they want or a startup that allows certain members to freeride off of other employees’ efforts. As a result, in the long run, if a startup wants to attract VCs or other institutions, it is ideal for the company to consider issuing stocks on a vesting condition.