There are three parts under Key Holder Matters in the Series Seed term sheet: (i) a four-year vesting, (ii) a full acceleration upon “Double Trigger” and (iii) all relevant IP assignments before closing.
Investors want to ensure that founders are incentivized to stay at the company and work hard to increase the value of the company. One tool commonly used to achieve this objective is to ensure that the founders’ shares are vesting. This means that even though the founders own their shares, the company can repurchase some shares if the founder quits or gets fired. The number of shares the company can repurchase is limited to the number of shares that have not yet vested. Vesting happens on a schedule, in this case over four years. So as time passes, the number of shares the company has the right to repurchase (upon termination) decreases, and the amount of shares the founder owns free and clear increases.
Take the example where the founder has 100 shares and a four-year monthly vesting with a one-year cliff. The one-year cliff means the founder will receive 25 shares (1/4 of 100) after one year. After the cliff, the remaining three years are separated into 36 months (3 x 12). Thus, after one year, the founder will receive approximately 2 shares (1/36 of 75) every month (1/48 of the original grant).
The four years vesting commences on a date to be negotiated. A point of negotiation is when to start the vesting provision. The investor would want that date to be as late as possible, to ensure the founder is incentivized for as long as possible. However, anybody who has founded a company knows how much blood, sweat and tears it takes to get to the seed stage investment. They are most often living off savings, eating instant noodles and working every waking hour. There is a very fair case to be made that this type of sacrifice should certainly count toward the vesting schedule. So, founders should push for the founding of the company (or even the date you started working on the project full time) as the commencement of the vesting period.
What happens if your company is acquired before you fully vest? That’s where the double trigger acceleration comes into play. Once the company is acquired (first trigger) you continue to vest your shares on the same schedule until you are terminated (second trigger), then all of your shares vest immediately.
The double-trigger requires that (i) the company is acquired, and (ii) the founder’s employment has been terminated without cause after the acquisition, in order for the shares to be fully vested. Typically, the qualifying termination means ending employment by the company without “cause,” but can also include resignation by the employee for “good reason” (e.g. a cut in pay, mandated relocation or significant downgrade of duties). The occurrence of these two events will give founders ownership of all the shares they are entitled to. The acceleration is designed to protect the founders from finding themselves in a vulnerable position where their employment is terminated by an acquirer.
Intellectual Property Assignment
The assignment of intellectual property from founders or employees to the company is essential for any startup. Most startups’ only asset is their intellectual property, so it’s crucial that there is no question as to the ownership of such intellectual property. Ideally the founders should have assigned relevant intellectual property upon incorporation, and each employee or consultant should have done so upon hiring. This is generally achieved through an agreement known as the Confidentiality and Inventions Assignment Agreement. The investors are just ensuring that this has been done. This is a good thing for both investors and the startup.
Why care about Key Holder Matters
Once the shares are vested, the founders retain the shares even if they leave the startup. However, the founders will lose the right to the unvested portion of the shares if they leave employment before all the shares are vested. Investors want a vesting schedule because it incentivizes the founders to stay with the startup and keep growing the business. Most of the time, seed stage investors invest based on the talent of the founding team. Seed stage startups usually have little sales or growth data to justify investment alone. A large portion of the investment value is in the founding team; thus, investors want the team to stay with the startup and keep growing its business. A vesting schedule prevents the founders from leaving the startup prematurely.
Additionally, a company with double trigger vesting schedules is a more attractive acquisition target. When an established company is acquiring a startup, oftentimes one of the most valuable elements of the acquisition is the talent, specifically the founders. Therefore, a company is more likely to sell (and make money for investors) if the founders are incentivized to stick around after the acquisition.
Lastly, since the core value of the startup is often in its intellectual property, the investors want to ensure that the company actually owns it.
In the Series Seed term sheet, the future rights are as follows:
Key Holder Matters: Each Key Holder shall have four years vesting beginning [_______]. Full acceleration upon “Double Trigger.” Each Key Holder shall have assigned all relevant IP to the Company before closing.
Thus the company is required to put the following restrictions on the founders. It is in the founders’ best interest to negotiate for either removal of the vesting restrictions or to ensure the starting date on the vesting schedule as early as possible.
In order to stay informed check our Founder’s guide on SEED funding.