Why you need to set up a vesting schedule
A vesting schedule might sound like choosing a different snazzy vest to wear each day of the week, but it’s actually an important legal and logistical step that can build trust and protect everyone involved when you go into business with your bestie.
This came up in my conversation with ADAY co-founders Meg He and Nina Faulhaber in episode 1 of the Chief Best Friends podcast. I didn’t know much about vesting schedules at the time, so I decided to dig deeper. Here’s what I learned:
What’s a vesting schedule, anyway?
A vesting schedule, or vesting scheme, has a few different definitions. If you’re an employee of a business, it might refer to the length of time you must work for a company before you’re entitled to any retirement contributions the company made.
In the context of a startup company, a vesting scheme is a formal agreement between business partners that states when a partner will gain full ownership of their portion of the company.
If that agreement is broken and the partner leaves the company early, they do not continue to receive benefits from the company. Before then, they can still make money, but they can forfeit their rights to the assets and profits if they leave before the vesting term is completed.
Most of the time, a vesting schedule states that partners get nothing for the first year of business and that they start gaining equity and accruing rights to the business assets after a year or two. They also give the remaining partner to buy back the departing partner’s stock in the company.
In a nutshell, a vesting agreement ensures that one partner can’t leave the company and leave the other partner with nothing.
This is especially important for startups because businesses tend to be financially volatile in the beginning stages. If you don’t set up a vesting schedule, it can be devastating for the business if someone leaves and takes a bunch of assets with them.
A vesting schedule ensures that if your partner suddenly leaves the company after a few months, they don’t automatically own half the company and continue to make money from the business. They’ll have to stick around for a while to fully own their portion of the business, and the option will still be available for the you to buy back your partner’s stock.
Basically, you only earn money from the company if you’re working on the company, up to a certain period of time.
Doesn’t that get weird when your partner is your friend?
I know what you’re thinking. If you’re going into business with a friend, how can you ask them to agree to a vesting schedule? Isn’t that like telling them you don’t trust them to hold up their end of the bargain?
It doesn’t have to be that way. The reality is, sometimes people leave the business for good reasons, not just to screw someone over. Someone might leave for another opportunity, an unforeseen event, or an emergency.
It also protects your business partner if YOU change your mind. If you approach it that way when you bring this up to your bestie, it sounds a lot less like an accusation. Sometimes people change their minds. It doesn’t make anyone a bad person, it just means that things come up, life happens, and you want to make sure everyone is protected.
If you aren’t convinced yet, a vesting schedule has a lot of other great perks.
Other reasons why you should set up a vesting schedule
1) You’ll avoid capital gains while the business is still getting a foothold
A vesting schedule allows you to legally avoid capital gains taxes for a while because if you don’t actually own those business assets and everything could be forfeit, you aren’t taxed on it. This is very helpful when you’re running a startup and stretching to make ends meet as it is!
Keep in mind that not all countries tax businesses the same, but it’s usually in everyone’s best financial interests to stick to the vesting schedule.
2) Provides clarity and division of responsibilities
Formal agreements like a vesting schedule give you and your business partner a chance to hash out the details of who will do what in the business, who is entitled to what, and avoid big communication breakdowns in the future. A legal agreement also demonstrates that both of you are serious about the business. If you or your partner isn’t okay with this, the business might not be right for you.
3）Protects your investors
A vesting schedule also protects your investors because the company will still retain its assets if a partner leaves early. This allows your investors to continue to make money from the business and helps the company avoid a financial meltdown that could compromise the success of the business.
4）Strengthens trust between partners
Think about it. When you have a legal vesting schedule in place with your partner, both of your asses are on the line. You both know the other can’t walk away and take everything, so you can trust that they’ll hold up their end and that if they don’t, the other will be protected.
Instead of worrying about one person leaving and screwing the company over, you can both focus on making the company successful!
5）Provides a vetting process for you and your partner
A business partnership is all about finding an agreement and being on the same page, just like a marriage. A vesting schedule gets you on the same literal page with both your signatures on the dotted line.
If someone isn’t okay with this, you know that’s a big red flag. If your partner finds a legally binding agreement like a vesting schedule slimy or wrong in any way, they may not make the best business partner.
And if YOU don’t like the sound of this, you might not be ready to commit to the company either.
And that’s okay. Better to find out now than later.
Get yourself a vesting schedule
Before you and your bestie tie the business knot, do yourselves a favour and talk to a lawyer experienced with business law and vesting schedules. They can answer any questions you have about creating a vesting schedule in the state and country you live in and start your business off on the right foot!