What actually happens when a founder leaves their startup?

Photo by Joel Peel on Unsplash

The short answer is, it depends…

This is a follow-up post to the one I wrote on vesting, if you haven’t read that then I’d recommend starting here.

Now it’s pretty much universally accepted in early-stage financings that vesting is a crucial term to include and get right. However, following numerous discussions with founders we have backed recently, it seems that there remains confusion around how the mechanics of vesting play out in the event that a founder leaves. We hope this mechanism never needs to get used but shit happens and I always encourage founders to clearly understand each and every term on their term sheet so there are no unnecessary surprises down the road.

As ever, exactly how it works is dependent on the specific terms but broadly speaking there are a few ways that I’ve seen this structured in practice and they often hinge on the question of whether the founder is a good leaver or a bad leaver.

The most typical elements (note: this is not an exhaustive list) that these key concepts cover are:

  1. Good Leaver – A founder who leaves in circumstances where they are generally not at fault e.g. death, permanent incapacity or where they are wrongfully terminated
  2. Bad Leaver – A founder who leaves in circumstances where they have done something wrong e.g. gross misconduct, criminal offences like fraud or other termination with cause

Once you’ve determined if they are a Good or Bad Leaver, then the question becomes how much have they vested?

A Good Leaver will usually be required to transfer the shares they have vested and are entitled to to the company when they leave and will receive “market value” for the shares they transfer. Alternatively, they may be allowed to retain their vested shares. This is seen as fair because they have built value in the company and should be entitled to such value and the way they have left is through no fault of their own.

A Bad Leaver is generally, as a default position, required to transfer the shares they have vested back to the company at nominal value (often a very small amount, e.g. £1). This is sometimes limited to the most serious type of bad leaver scenarios and there is usually some discretion of the board/company built in.

How is this actually achieved by the company in practice?

The mechanism of how the company deals with the transfer of such shares is set out in the company’s articles. Shares could be bought back by the company, transferred to an option pool, made available to a new hire / joining founder (maybe via the option pool), or offered to the other shareholders. I often see Bad Leaver shares automatically converted into worthless deferred shares. I understand from counsel (although tax advice should be sought) this can be helpful, as it is tricky to transfer shares to employees below market value without creating tax issues.

What about the unvested shares?

The default position is that all unvested shares are treated as worthless regardless of how the founder leaves the company. Again, there could be some discretion available to the board that they may look into in the event of a Good Leaver.

The caveat to this is in the case of an acquisition, where there may be an acceleration of the vesting schedule so that a proportion or in some cases all of the shares become vested. Often not only the acquisition but also the firing/departure of the founder is required to “trigger” the acceleration. This is referred to as “double trigger acceleration” (acquisition + leaving). The theory here is that this is fair because if there is an acquisition and the founder is fired/asked to leave etc. then they have done nothing wrong and should be entitled to all their shares. Also, the double trigger ensures that there is a mechanism to protect the acquirer from having a disincentivised management team in the event they don’t fire them and want them to continue to work in line with their vesting schedule.

Anything else to consider?

Lots! The above is a framework and sets out the basics of how the good leaver and bad leaver provisions interact. Its a basis to start from and often negotiations, either at the term sheet stage or when a founder is departing will lead to variations of the above.

Final thoughts

Firstly, I truly believe that any vesting schedule should be seen as not only an investor protection provision but also a founder protection provision (i.e. something that protects founders from each other). My view is that investors can provide frameworks but it is crucially important that founders buy into the benefit and structure of any vesting schedule. A well-designed vesting structure and leaving mechanic puts the company in the best possible position to weather any future storms. I generally recommend a clean and concisely drafted version of the “Good Leaver, Bad Leaver” mechanism as the best approach. This appropriately recognises work done by founders by allowing the retention of some or all vested equity whilst also providing an approach should founders leave before a startup’s journey is complete.

Originally posted on Medium.

Why convertibles make more sense by setting a post-money cap

A simple change that can reduce complexity for early-stage financings

Photo by Ahmed Syed on Unsplash

A challenge that I see founders struggle with when raising money using a convertible (note: I’ll use convertible as a term to capture advanced subscription agreements (ASAs) and/or simple agreements for future equity (SAFEs) throughout this post) is correctly understanding the dilution they are taking. This has traditionally been one of the advantages of doing an equity round (where shares are issued at the time of investment) because it allows everyone to have a clear picture when the round closes of where they stand from an ownership perspective. However, for multiple reasons (time, cost etc.) often an equity round isn’t a founder or investors preference at the earliest stage.

I think there is a simple fix to this problem, set the cap in the convertible as a post-money valuation.In this scenario, the post-money is in relation to any money raised under such convertibles (see below for an example) but, to flag, is not inclusive of the money raised at the converting round (i.e. Seed or Series A). This is something that we have incorporated in the standard advanced subscription agreement we’ve been using for our pre-seed investments at Seedcamp. It’s also something that YC have recently incorporated in their standard deal documents. 

So, how does this work in practice?

Firstly, I’ve written previously about considerations to bear in mind when setting caps. If you haven’t checked that out, I’d recommend starting here.

The difference between using a post-money and a pre-money cap is best illustrated using numbers:


If you were to raise £100k and set a cap at £2m post money then on conversion at the cap the investor would own:

£100k / £2m * 100 = 5%

If you raised an additional £150k on the same cap that would add an additional:

£150k / £2m *10 = 7.5%

Total dilution => 5% +7.5% = 12.5%


Suppose you went out to raise £100k and agreed to give up 5% of your company for this. Using an ASA you, therefore, set a cap at £1.9m pre-money. On conversion at the cap the investor would own:

£100k / (£1.9m +£100k)*100 =5%

So far the same as the post-money scenario. If you then went on to raise an additional £150k on the same cap that would add the following dilution:

£150k / (£1.9m+£250k)*100= 6.97%.

This is lower than the post-money scenario because the additional amount raised has been added to the pre-money cap resulting in a new cap for the purposes of calculation.

Furthermore, as the cap has effectively increased by this additional £150k, the original £100k would now equate to the following dilution:

£100k / (£1.9m + £250k ) * 100 = 4.65%

Total dilution => 6.97% + 4.65% = 11.62%

The above is a very simplified example but you can imagine how complex this can get when using a pre-money cap to raise investment from multiple investors.

Why the concept of time is crucial

As the above illustrates, the pre-money example actually results in less founder dilution and therefore could be seen as founder favourable. This is because each incremental amount raised using a post-money cap just dilutes the current shareholders which at the pre-seed stage are usually the founders. However, I think the key concept to layer onto this analysis is time. A startup can be seen as having a value attributable to a certain period in time. The post-money method allows founders to clearly define what the valuation of their startup is for a period of time that they will raise convertibles for. Often this time period is pre a large institutional Seed or Series A. By clearly defining this time and setting the post-money cap for this period it allows founders to have a very clear picture of the dilution they are taking at each funding event documented using a convertible and therefore where they stand going into the Series A. Obviously if this time period is particularly long, a founder could determine that there are two or more distinct periods prior to the large institutional Seed or Series A and therefore there is a higher cap for the second or additional period. There are numerous ways that founders and investors can get creative to structure such financings but I think a key driver should be simplicity and speed and the post-money approach helps with this.

The exact timing of when the mechanic of conversion takes place is another area that can cause confusion. For example, often convertibles are drafted as being inclusive of an option pool that may be requested at the round in which it converts. This can add additional dilution for founders because it means that the dilution of the future option pool comes before the convertible is converted and is therefore borne by the founders and not the note holders. This is not a particularly unusual provision but it is something for founders to be aware of. For example, a pre-money cap that is inclusive of any option pool could end up resulting in a similar level of dilution as a post-money cap not inclusive of an option pool.

Overall, I think the focus should be on simplicity and speed. I do think navigating to a post-money world helps with this and provides a clearer basis for founders and investors alike.

Originally posted on Medium.