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Vesting Schedule & Follow-On Financing

As discussed in prior lectures, investors will seek to use a fully diluted capitalization calculation when investing in a startup. This includes the shares issued but not fully invested in founders. As such, the founders may want all unvested shares to vest at the time of investment in order to add increased certainty to the capitalization calculation. This is known as a change-of-control vesting provision. It is triggered when either the business is sold or equity investors acquire a controlling interest in the company. This provision protects the founders in the event that the investors influence will seek or cause the founder to leave the business. Investors do not favor these provisions, as it may diminish the incentive that the founders have in working for the business. As such, the corporation may need to offer options or some form of earn-out arrangement to incentivize the continued performance of these founder employees. Investors will also argue for increased stipulations on the change-of-control vesting provision. For example, the investor may include a requirement that the founder is fired without cause or there the conditions effectively force the founder out of the business within a stated period following the change of control. Effectively forcing out a founder/employee is known as constructive termination.

• Note: Expect investors to force a vesting schedule onto founders as a condition at the time of financing.