When a Founder is Fully Vested: Compensation, Displacement, and Equity Management

Introduction

The market dynamics surrounding a founder's vesting is a subject of significant interest in the startup world. When a founder or CEO becomes fully vested, it presents unique challenges and opportunities for companies. Whether the founder/CEO leaves or stays, the process and implications can be complex and often uncharted territory for all involved.

Market Dynamics and Compensation (Keyword: Founder CEO, Market Grant)

Imagine the scenario where a founder/CEO is fully vested but decides to leave the company. In this case, the company must hire a new CEO who will receive an equity grant typically ranging from 2.5% to 7.5% of the company's equity, depending on the company's value. Some argue that this equity grant should reflect similar compensation, akin to what the founder CEO received at the start.

However, this argument introduces a critical question: Is the founder CEO truly the best person to lead the company, or is there someone else better suited for the role with a more valuable market grant? While it might appear in the best interests of the company to have that discussion, it often doesn't happen, as both parties tend to avoid such emotionally charged debates.

Founder CEO Ownership and IT

Many founder CEOs still own a significant portion of their company several years in, typically between 10% and 40%, depending on co-founders and early fundraising dynamics. As a result, the new equity grant offered to the new CEO is a relatively small percentage of the founder CEO's overall equity. In this context, the new grant is not as valuable to the founder CEO as other compensations.

One of the most valuable assets to a founder CEO is a large, unissued equity pool. This pool allows the founder CEO to hire talent more competitively. Any allocation of this pool to the founder CEO reduces its size, thus diminishing its value.

Vesting and Equity Refresh Grants (Keyword: Vesting)

Boiling down the concept of vesting, it is often a good practice to have all employees vesting into some form of equity compensation to standardize the compensation program and align incentives. For an employee, their vesting grants typically reflect a certain percentage of their sign-on grant. Similarly, refresh grants for employees are usually a percentage of their initial grant, though founder CEOs, who never received a sign-on grant, have different dynamics.

Investor Alignment and Pre-Money Valuations (Keyword: Equity Compensation)

Investors typically focus on the appreciation of the equity they already own, rather than the issuance of new equity. Founder CEOs should be aligned with investors by focusing on increasing the value of their existing equity. Negotiating a new “market grant” for a fully vested founder/CEO that was previously agreed upon during financings is rarely done, as it would require pre-negotiation and a clear understanding of future dilution.

Finding Stability in Dynamics (Keyword: Option Pool)

When founders often see themselves diluted below double-digit ownership, they start to view themselves as employees rather than owners, which can harm the company, team, and investors. Many founders feel this way when their ownership is below 20% or 15%. Since what happens after a founder becomes fully vested is not typically negotiated in advance, it is rare for it to be included in pre-money valuations. As a result, both parties may naively or purposefully put off the decision until it becomes a pressing issue, leading to potential conflicts and emotional debates.

Ultimately, the situation arises due to varying interests and strategies. Ensuring that the founder/CEO's equity is properly managed and aligned with both the company's goals and the investors' interests is crucial for the long-term success of the startup.

Key Ideas: The founder/CEO’s market grant when leaving should reflect similar compensation. Founder CEOs often own significant equity, making new grants less valuable. Vesting and refresh grants are standardized to align incentives. Investors focus on the value appreciation of their existing equity. Founder CEOs must maintain their ownership and alignment with investors.