In the traditional small business, the magic ingredient is usually cash. You start a restaurant, someone funds it. Others work it. Those who work it get paid as they go and do not work for equity. Therefore, if anyone becomes an owner and fails to work in the business, or starts to work for a time but then walks away, then no harm, no foul. No one is hurt and it usually does not matter that the person who walks away keeps his equity.
Not so with a startup, which builds for the future and whose initial assets generally consist of only partially developed intangible rights that might one day have great value but that will have that great value if and only if people stick around to develop it through a lot of hard work. Here, those who work in the business typically do not get paid, or do not get paid anywhere close to what they are worth in the broader employment market. They work for equity in whole or in part and they are paid in “sweat equity.”
For most startups, founders are founders but are workers too. All concerned usually expect that such founders will stick around for at least several years (typically four), work hard, and earn any equity granted to them by helping to build the value of the venture. In such cases, it is an obvious mistake (absent special circumstances) to do the founder grants as outright unrestricted grants that are owned once and forever by the founders immediately as of the time of grant.
If such grants are made, and one or more founders walk away, they keep their equity and get a windfall. The remaining founders and others involved in the venture wind up working for them or funding them as they sit by taking no further risk and contributing nothing beyond what they initially did before leaving.
And so startups almost universally use founder vesting as part of their setup model. The norm is 4-year monthly pro-rata vesting. A one-year cliff is sometimes used and for this see Q&A 5 below.
Startups come in many shapes and sizes, however, and there are times when founder vesting is not appropriate.
The need for vesting arises because a founder has not yet built sufficient value to earn his or her shares. Exceptions are made, then, to the extent one or more founders has already built value that is contributed into the venture.
Sometimes it is one dominant founder who had the idea and who did months or even years of initial development before putting together a team. For the others, the key pieces are hence already in place at company formation and they will need to earn out their pieces for future contributions. But for the dominant founder, the work has already been done to justify the value of the initial stock grant. Therefore, in such a case, that founder may get a share grant without any vesting restrictions or may get a grant of which only a fraction will be subject to vesting.
So too with multiple founders who have each worked at something for non-trivial periods before formation, each such founder may get a grant with part of the grant being immediately pre-vested and hence not subject to forfeiture. The idea is that the immediately vested portion reflect the value of what a person has already done, it being unfair that someone should be at risk of forfeiting such equity if payment for it was based on work already done and not on the promise of future work.
A quick example: Founders A, B, and C launch a venture, with A having come up with the idea and developed a working version of a prototype over a 3-year period and with B and C having joined A to help with the development for six months prior to company formation. The venture has 10M authorized shares, of which 6M are granted to the founders at the start.
Of course, all is negotiable but, here, A might get 4M shares with no vesting requirements or with only 50% (or some similar number as negotiated) subject to vesting, while B and C might each get 1M shares subject to 4-year vesting with 10% of each of their grants being pre-vested to reflect the fact that they had already earned it through their prior efforts.
As shown in this example, vesting does not have to be uniform. You can mix, match, and customize to fit your particular case to ensure that various pieces have to be earned while others have already been earned either entirely or in varying degrees. It is all highly customizable.