Founders Shares (Founders Stock)
If you’re in the process of evaluating whether or not to issue founders stock, or founders equity, there are some things you should be aware of. In this guide, we cover everything you’ll need to know—including what it is, how it works, when it's issued, how to allocate it, and how it compares to other forms of equity such as preferred stock, stock options, and common stock. We also provide best practices to help you reap the rewards of your equity. Let's dive in!
What are founders shares?
Founders equity, like common or preferred stock, is a form of ownership in a company. As the name suggests, it is typically only issued to the founders (and first employees) of a startup. Individuals who own this form of stock are granted special rights and privileges that are not available to common shareholders, such as the ability to vote on the company's executive team, strategy, operations, and future fundraising efforts as the company grows.
How do founders shares work?
Founders shares are a sort of hybrid equity between common stock and preferred stock.
For context, common stock typically has a lower strike price (based on the fair market value), comes with restrictions on the sale or transfer of the shares, and no voting rights. Preferred stock, on the other hand, has a higher strike price, can be sold on secondary markets, and comes with voting rights.
Founder shares are considered a mix of the two because they are issued at a lower strike price than preferred shares, they can be sold or transferred, and they come with voting rights. They may also come with special rights and privileges, such as super-voting rights, which allow founders to have even greater voting power compared to the preferred shareholders. In these cases, the “super-shares” come with twenty-five, fifty, or even a hundred votes per share, compared to just five or ten votes per preferred share.
When are founders shares issued?
Founders shares are typically issued when a startup is formed before any other equity has been purchased by investors or venture capital or stock is issued to employees. Founders do this because it enables them to minimize the tax implications—e.g. they can file special elections that enable them to pay taxes on the deferred gains at the time they were issued rather than when the shares vest. That said, the specific timing around the issuance of the founders shares varies and may be issued at a later time.
How to allocate founders shares?
The allocation of founders shares is an important decision of any startup. The main objective should be to allocate them in a way that is equitable and beneficial for all involved parties.
While there is no perfect method, there is one that should be avoided—splitting the equity equally between all members of the founding team. The reality is that there must be a single leader who has more equity and thus has the decision-making power. For example, if there are three founders of a tech company, consider splitting the founders equity as follows: 35% for the CEO, 32.5% for the COO, and 32.5% for CTO.
Pro-tip: consider including language in the founders stock agreement that enables you to repurchase the majority (>75%) of a founder's shares at a multiple between 2-5x the original strike price in the event of their pre-mature exit.
What is the typical vesting schedule for founders shares?
One of the most important aspects of founders equity and all other forms of equity is its vesting schedule, which outlines when the individual can access their shares. Having one ensures that the founding team remains with the company and contributes meaningfully to its success.
Typically, the vesting schedule for founders shares is four years, with a one-year cliff. This means that the founders cannot access all their shares until four years have passed. However, at the one-year mark they can access ¼ of their shares, and each month thereafter, they can access or ‘vest’ 1/36 of the remaining shares. That said, vesting schedules vary from company to company.
In addition to the vesting schedule, there may also be certain milestones that must be met for the founders to receive their shares. These milestones can include the completion of certain milestones or the achievement of certain financial targets.
Super-voting rights with founders shares?
Founders shares typically come with special voting rights that are not available to other shareholders. These rights, known as super-voting rights, allow founders to have greater voting power than other shareholders. Super-voting rights are typically granted to ensure that the founders have a say in the direction of the company—such as the right to approve major strategic decisions or the issuance of new shares.
Super-voting rights can be granted in a variety of ways. The founders can have a certain number of votes per share, or they can have a specific percentage of the total votes. In the former case, the “super-shares” may come with twenty-five, fifty, or even a hundred votes per share, compared to just five or ten votes per preferred share.
Common restrictions on founders shares?
In addition to the vesting schedule, there are also typically certain restrictions placed on the founders shares. These restrictions ensure that the founders remain with the company for a specified period and continue working towards the company's success. Common restrictions on founders shares include a lock-up period, transfer restrictions, and repurchase rights.
- A lock-up period is a period of time during which the founders cannot sell or transfer their shares.
- Transfer restrictions prevent founders from transferring their shares to another entity or individual.
- Repurchase rights give the company the right to repurchase the founders' shares if they decide to leave the company.
Compared: founders shares vs preferred shares?
While founders shares and preferred shares have similar characteristics, there are some key differences.
- Voting rights: While both preferred shares and founders shares come with voting rights, preferred shares do not come with super-voting rights, which have greater voting power.
- Strike price: The strike price of founders shares is based on the fair market value of a startup and thus is at a lower price than preferred shares.
- Dividends and payments: Preferred shares typically grant shareholders the right to receive dividends and other payments. In contrast, founders shares typically do not grant the founders any such rights.
Compared: founder shares vs options?
Founder shares and options are completely different forms of equity.
- Voting rights: Options typically do not grant any voting rights, while founder shares typically grant holders super-voting rights.
- Strike price: One of the main differences between founder shares and options is the price at which the equity can be purchased. With options, the holders are granted the right to purchase shares in the company at a predetermined price in the future. In contrast, with founder shares, the holders purchase shares at the current market price.
Compared: founder shares vs common stock?
While founder shares and common stock may both be issued to founders and early employees there are some key differences to note.
- Voting rights: Typically common stock does not come with voting rights, whereas founders stock comes with super-voting rights, which give holders greater voting power.
- Sale or transfer rights: Typically holders of common shares cannot sell their shares until a liquidity event, whereas holders of founders equity may have the ability to sell their shares on the secondary market before a liquidity event.
- Other rights: Holders of founder shares typically have certain rights, such as the right to approve major strategic decisions, whereas holders of common stock do not.
Best practices for reaping the rewards of founders equity
As a startup founder, it is important to understand how to best utilize your founders equity. Here are some best practices for reaping the maximum rewards from your equity:
- Make sure you understand the terms of your equity agreement. This includes the vesting schedule, super-voting rights, and other restrictions that are in place.
- Leverage your super-voting rights to influence strategic company decisions, such as the issuance of new shares, the pursuit of an acquisition, or a liquidation event.
- Set up a vesting schedule that incentivizes the rest of the founding team to stay with the company for a specified period, usually two to four years.
- Understand the tax implications of your equity and if applicable take advantage of Internal Revenue Codes, such as 83b, which enable startup founders and employees to pay taxes on the total fair market value of the restricted stock to limit the income taxes.
Co-Founder equity calculations
For startups with multiple founders, it is important to determine an equitable way to split the founders equity. This can be done by using a co-founder equity split calculator. The calculator takes into account the founders' contributions, such as the number of hours invested, the type of work performed, and the amount of capital invested. Here are a few of the top founder equity calculators: foundrs, gust, capbase.
What are the benefits of using founders shares or founders equity?
There are a few key benefits of using founders shares including
- Maintain control: by issuing this form of equity, founders can maintain the majority say in strategic decisions of the company even if they have <50% of the total equity pool.
- Align interests: founders shares can align the interests of all founders towards driving growth and the overall success of the company.
- Talent: issuing this form of equity can help startups attract key members of the founding team and minimize churn.
What are the drawbacks of using founders shares or founders equity?
There are a handful of drawbacks associated with issuing founder shares, these include
Internal hostile takeover: if one of the members of the founding team decides to leave but is allowed to keep their shares, they may still have the power to push through or block decisions thereby impacting the direction of the company.
- Unfair distribution of equity: founders may not always be able to accurately gauge the contribution of each stakeholder, which may lead to an inequitable split.
- Detract investors: Investors may be wary of investing in a company with a high percentage of founders equity, as they may not be confident that the founders will be able to effectively manage the company.
Common pitfalls to avoid when issuing founders shares
If you’re considering issuing founders shares, there are a few common pitfalls to avoid. These include:
- Over-issuing equity: founders should be mindful of how much equity is issued and should make sure that the split is fair and equitable.
- Handing out founders equity-like hotcakes: founders stock should ONLY be granted to those who have significantly contributed to the growth and success of the company.
- Not putting restrictions in place: individuals who have founders stock should be subject to lock-up periods, transfer restrictions, and repurchase rights.
- Poor documentation: Founders should make sure that their equity structure is well documented, and includes a shareholders agreement that outlines the rights and responsibilities of each stakeholder.
Final thoughts on founder shares
Understanding how to structure founders equity is essential for maximizing the outcome of your startup. If you plan to issue founders stock, make sure that you: limit who receives it, have restrictions in place to limit the downside risk, and document the program thoroughly. This will ensure that you can maintain control even if you have <50% of the total equity pool and that you can attract other key members of your founding team.