Reverse Vesting (Stock Options) - Explained
What is Reverse Vesting of Stock Options?
Written by Jason Gordon
Updated at April 15th, 2022
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Table of Contents
What is Reverse Vesting of Stock Options?Example of Reverse VestingAcademic Research on Reverse VestingWhat is Reverse Vesting of Stock Options?
Reverse Vesting is a concept applied to founder equities. Although they own the shares of their company at the outset, the company has the option to buy back their shares if they decide to leave. The percentage of shares the company can buy back in such an eventuality decreases as the duration of the founders stay with the company increases. It's kind of a Reverse Vesting scenario where the longer a founder stays with the company, the lesser the number of shares the company can buy back from them if they decide to quit.
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Example of Reverse Vesting
If a company founder X owns 30% stake in the company, and the Reverse Vesting plan in place specifies that X gains permanent ownership of 20% of the shares every year, then X needs to stay with the company for 5 years to actually own all of the shares permanently, to be sold at his discretion, or passed on to heirs. This doesn't mean that 30% stake of the company is unowned, the voting power for that 30% stake rests with X in the interim.
After 5 years, this Reverse Vesting schedule is complete and the company cannot buy back Xs shares even if he decides to quit. Suppose X decides to quit the company after 3 years, he retains 18% stake in the company. The remaining 12% of his shares can be bought back by the company at a reduced cost to retain voting powers.
Importance of Reverse Vesting
Venture capital firms use Reverse Vesting as a way to monitor their investments and safeguard them from founder turmoil. Such agreements protect the interests of the company, shareholders, and investors, in the eventuality of a founder deciding to quit the company and taking away with them a large chunk of shares.
It also helps companies retain voting rights for members who are actively responsible for the growth and operations of the company. The agreement between investors and founders/co-founders that facilitates Reverse Vesting and the option to buy back stocks, is called the Restricted Stock Purchase Agreement.
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