The standard four-year founder vesting schedule can leave departed founders with large equity stakes, complicating financing and control, and prompting costly litigation. Guest author David Siegel, a partner at Grellas Shah LLP, shares ways startups can reduce these risks.

What dead weight actually costs your company

When a co-founder with substantial ownership leaves — voluntarily or involuntarily — they often walk away with a massive, permanent piece of the company. From a VC’s perspective, and that of the remaining partners, this is pure dead weight. You now have someone holding 15% to 20% of the equity who is no longer providing any value. Of course, contractually it’s theirs, and they’ve usually earned it. Practically, it can break the company in three distinct ways: It kills motivation; the remaining team has to grind for years toward an IPO or acquisition, knowing that a fifth of the exit payout is going to someone sitting on the sidelines. It breaks future dilution pools: when you need to bring in new executives or raise a new VC round, your outstanding share count is artificially bloated by a departed founder. Issuing a simple 1% option pool suddenly requires 20% more shares than it otherwise should. It creates voting and control nightmares: if a departed founder owns 20%, you need their signature on standard investment documents and major shareholder votes.

The shrinking threshold of tolerance

Five to 10 years ago, investors might have tolerated a departed founder holding 5%, 10% or even 20% of the company. Today, that threshold has collapsed. Many VCs will now insist that a former founder hold no more than 2.5% of the cap table. However, because the standard four-year vesting agreement has no contractual mechanisms to claw back shares, companies start looking for alternative ways to do so when a founder leaves. Initially, this usually involves pressuring them to give up shares for the goodwill of the company. When that fails, they sic investors on them, threaten their professional reputation, and sometimes resort to litigation. These are multi-hundred-thousand-dollar lawsuits that never would have been filed except as a desperate attempt to claw back departing founder equity.

The four-year vest, one-year cliff standard is a very lemming-like system in which founders follow the same standard as everyone else. They often pull the language in equity agreements off automated legal platforms because it’s cheap, fast and requires minimal thought. If we want to fix this problem — and I believe every startup should — the industry needs to converge on a new, more nuanced position built into founding documents from day one.