Founder shares

What are founder shares?

Founder shares (also called founder stock) are a type of equity, usually common stock, issued to the founding members of a company immediately or soon after it’s incorporated. These shares are typically granted before any outside investors come on board and establish the initial ownership of the company.

Why are founder shares important? 

Founder shares are crucial for several reasons:

They establish ownership

Founder shares define the initial ownership percentages among co-founders. This clarity helps establish roles and responsibilities among the founding team members and ensures that everyone is aligned. 

They attract investors

A well-organized equity structure can instill confidence in potential investors, making it easier to secure funding. Investors like to see a transparent cap table that outlines ownership stakes for everyone involved—including the founders.

They incentivize long-term commitment

The vesting schedules often associated with founder shares serve as a powerful incentive for founders to stay committed to the company's success. These vesting schedules often include specific vesting periods, ensuring that stock vests gradually over time. For example, a founder's shares might fully vest over four years, with a one-year cliff (a cliff is an initial time period the founder must work at the company for any of their shares to vest).

By tying equity ownership to time- or performance-based vesting restrictions, founders are more motivated to contribute their best efforts, ultimately benefiting the company and its stakeholders. If a founder leaves before their shares have vested, the company can repurchase the departing founder’s shares at cost, which prevents the departing founder from receiving an unfair benefit from the founders who stay longer.

It is very important for founders to be aware of the benefits and deadlines for filing an 83(b) election with respect to their founders shares subject to vesting.

Key characteristics of founder shares

Founder shares have several defining characteristics that make them distinct from other types of employee equity or executive compensation:

Low price

Founder shares are usually priced at a nominal value, often as low as $0.001 per share. Founder shares can be priced so low because they are issued at the inception of the company, when the fair market value (FMV) is almost nothing. This approach allows founders to secure significant equity stakes early on, which can appreciate substantially as the company grows and its valuation increases.

Extra rights

Once issued, the holders of founder shares will control the company—and therefore be responsible for determining the officers and board of directors. As the controlling shareholders, the holders of founders shares and the board they appoint (if applicable) will be responsible for approving any corporate actions taken by the company, such as a decision to sell shares to investors or sell the company.

While most common stock (the stock issued to employees and other service providers) include voting rights, in some cases, the founder shares may also include additional rights like super-voting rights. Super-voting rights provide the founder’s shares with multiple votes per share compared to ordinary common shareholders. These additional votes help founders maintain control over their company, even if their ownership is diluted after future fundraising rounds. 

Lock-up agreement 

Most founder stock purchase agreements will include a lock-up agreement, which prevents them from selling their stock for a specific period of time following an initial public offering (generally 180 days). This is designed to prevent a large sell-off that could decrease the stock price and make the IPO less attractive to buyers. 

Equity dilution

As your company raises capital through various funding rounds, the percentage ownership of founder shares may dilute. However, founders can negotiate terms with new investors to maintain a certain level of control, such as the right to appoint members of the board of directors and other approval rights.

Structuring founder shares

Properly structuring founder shares is essential for avoiding conflicts and ensuring smooth operations. Here are some best practices:

Implement a vesting schedule

To ensure founders remain committed to the company, founder shares are often subject to vesting schedules. Vesting schedules outline the period over which founders earn their shares, reducing the risk of a founder leaving the company early with a significant equity stake.

It is very important for founders to be aware of the benefits and deadlines for filing an 83(b) election with respect to their founders shares subject to vesting.

Formalize agreements

Draft clear and detailed agreements outlining the allocation of founder shares, vesting schedules, and any potential buyback provisions. This clarity can prevent misunderstandings and disputes down the line.

Determine equity split

Determine a fair equity split among founders based on their contributions, roles, and responsibilities. Transparent discussions and agreements at the outset can prevent conflicts in the future. 

→ Use Carta’s co-founder equity split calculator to determine a fair split and facilitate an informed discussion. 

Consult experts

Engage experienced legal counsel to help structure founder shares and navigate the complexities of equity allocation. Legal expertise can ensure compliance with regulations and protect the interests of all parties involved, such as ensuring 83(b) elections are filed in a timely way.

Potential pitfalls and how to avoid them

1. Founder disputes: Disagreements among founders can arise, particularly regarding equity distribution and control. To mitigate this, establish clear communication channels and formalize agreements early on. While not common, some founders may decide to enter a Founder Shareholder Agreement to cover particular items of concern.

2. Dilution concerns: Dilution occurs when new shares are issued, reducing the percentage of ownership held by existing shareholders. While this can be a concern for founders, it’s essential to understand that dilution is a natural part of the growth process. Planning for how founder ownership may change with future funding rounds is essential. 

3. Lack of vesting: Without vesting schedules, founders who leave early can retain significant equity, potentially causing issues. Implementing vesting schedules ensures founders earn their shares over time. For shares subject to vesting, work with your counsel to ensure 83(b) elections are filed in a timely way.

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