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Vesting

October 21, 2021

One thing that I like about finance is that it is fundamental. Some people may have the perception of finance as moving money around and taking a cut. For some parts of finance there is truth to that. Many parts of finance, however, strive to figure out good solutions to problems that emerge naturally as soon as people are trying to cooperate on a project that will create value in the future. Finance, as with many things, can often feel simpler the more you learn about it as the veil of complexity is removed. I find this to be true for startup funding as well, and many of the terms that appear impenetrable at first boil down to issues that are fundamental to building something together with other people with different incentives (and all people have different incentives, but that's a topic for another day).

Vesting is one such part. It comes wrapped in legalese, but it addresses a highly fundamental issue: When several people are building something together that might produce rewards in the future, one person might leave along the way. Then there will be a question of how much, if any, of the potential rewards from the thing being built that the leaving person will reap. Some of the rewards, but not as much the people who continue? None of the rewards? Maybe it depends on the reason for leaving? For startups, the issue of vesting is usually brought up first when you raise some sort of external capital. However, note that the scenario described above is completely independent of any capital investment being involved. In fact, it doesn't even have to involve money at all. It is inherent to people working on something that may produce some kind of reward in the future.

Therefore this is something that all founders should be thinking about, not only those who are raising external capital. The reason is that this issue is there inherently, so not discussing it means that you have defaulted to a choice, without thinking about it. That choice can happen to be a horrible choice. In the context of a startup, the default is that the leaving person has the same rewards as the people continuing, regardless if that person leaves on day 1,000 or day 1. Same rewards. I doubt that many startups who choose this by unknowingly defaulting to it would make this choice if they were forced to make a choice.

It is usually easier to agree on these issues as a group before you start, as you typically don't know who will be the leaving person. Yet many startups don't discuss this until the question is raised by a VC. I think all founders should talk about this and find a solution that makes sense for them, not just unknowingly choose the default.