Vesting Agreement: What is it and should you get one?

A lot of founders and investors who want to know whether they should get a Vesting Agreement approach us. Our answer to them is: Absolutely! A Vesting Agreement serves different, but important purposes. A Vesting Agreement protects you when you want to offer shares to your employees to incentivise them to stay with your company and to perhaps achieve certain performance targets while doing so. A Vesting Agreement also protects you from the risks of founding or funding a startup. If one of your founders decides to leave early on and takes a portion of the company’s shareholding with them, then the other founders may be in trouble because they don’t have enough shareholding to incentivise a replacement. It is also unfair that the founder who has left still owns a portion of the company – particularly if you funded it, they didn’t, and they left before generating value from your funding.

Vesting Agreement concepts

There are certain key concepts regarding Vesting Agreements:

Vesting

Anyone who has shareholding in a company should be vested. Vesting means that the shareholder becomes entitled to the shares, including the rights in those shares.

Where the Vesting Agreement comes in is that instead of getting your full shareholding upfront, you get it regularly in portions over a set period. The Vesting Agreement regulates various aspects of that vesting, such as how long that period will be, how many shares will vest in each month or year during that period, and any performance targets that you might be expected to achieve for the company (if you are an employee, for example).

Cliffs

Vesting can result in lots of people each owning little pieces of the company, which makes future legal work difficult. Cliffs let you try out a partner in the form of a co-shareholder or incentivise a new employee with shareholding without parting with any shareholding upfront. If the vested person leaves during the cliff or perhaps fails to achieve certain performance targets that may be part of the deal, then they get no shareholding. The vested person gets everything that they would have accrued during the cliff period when the cliff ends.

Basically, if you agree with an employee, for example, that they will get 30% shareholding if they stay with your company for three years and help the company achieve a certain level of profit, subject to a 1-year cliff period, you can structure the deal in the following way:

• For the first year, they will get no shareholding if they leave the company or fail to complete the performance targets (and perhaps they might forfeit any chance to get shareholding even if they stay with the company for the three years);
• For the second year, they will only walk away with 10% shareholding (for completing the first year) if they leave the company before the end of the second year or fail to complete the performance targets
• For the third year, they will only walk away with 20% shareholding (for completing the first and second year) if they leave the company before the end of the third year or fail to complete the performance targets.

The point, really, is that you have a number of options for what you can say in your Vesting Agreement about a Cliff period.

Acceleration

Acceleration gives shareholders a portion of their shareholding if someone that they didn’t anticipate joins the company as a majority shareholder and their full shareholding if that person joins and fires them.

Advisers generally get ‘full acceleration on exit’. When you sell the company, they immediately get the equity that they were promised.

Is a Vesting Agreement advisable in South Africa?

Yes. That’s the short answer. While vesting is better-known in the US, where it exists legally and the terms are often in boilerplate documents, it is still possible to write it into a Shareholders Agreement if it will not be in a stand-alone Vesting Agreement.

Actions you can take

• Get good performance from key staff while retaining those key staff by asking us to draft a Vesting Agreement or Vesting clause.
• Avoid potential disputes with your shareholders by asking us to help you clarify how shares will vest in your company.
• Manage various risks and improve governance in your company by asking our advice on the King IV Code and IT Governance.
• Manage the relationship between shareholders by asking us to draft a new shareholders agreement or review your old shareholders agreement. The shareholders can also attend a shareholder workshop.