What is Founders Stock – Meaning, Features, And Importance

Who are the Founders?

Those who establish the foundations of the company or any form of business are called founders. In a more technical sense, they are the initial stockholders of the companies.

They put in their sweat to incorporate the company. They decided to convert their idea into the formation of the company.

Meaning of Founders stock

When founders form the business, in part of their ownership in the formation, they receive founders’ stock, i.e., equity in the business.

Founders’ stock depicts shares of common stock issued as per the consent of the board of directors.

When the company is organized at the beginning, the important documents are executed for incorporation, including a certificate of incorporation (COI), memorandum of association, and articles of association.

In COI, it is explicitly mentioned who are the initial stockholder. In corporate terms, founders are also called promoters of the company.

Features of Founders stock

Founders’ stock is generally a large percentage of stock given to individual founders. The stocks are issued at a nominal price.

At the incorporation, the company usually issues stock at a low price as it has not started to do any business.

The upside potential of the business is likely the compensation for the founders. To understand more about features, the following are the points to be noted:

Power of Control

The problem among newly established businesses, i.e., startups, is losing control throughout the business’s success.

This is due to the raising of more funds through equity. After some time, founders no longer entirely control the company business due to new investors, like joint ventures, angel investors, and private equity.

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However, to retain control, founders specify the class of shares with voting rights. For example, a special class of shares where voting rights are multiplied can be issued.

Another instance can be the power of founders to hire more than one or two directors in the Board seat. “Dual-class” shares are now in trend.

Mark Zuckerberg of Facebook still has high control over the decision making power of the company.

Vesting

Suppose a co-founder leaves the company due to exit by incoming investors, retirement, or pursuing other paths.

In that case, this can lead to complicated situations if the co-founder has large holdings. In start-up terms, this creates the “free rider” problem.

This means that the co-founder will benefit heavily if the company succeeds without him taking much risk and sweat for the success.

Hence, one of the widely used features of share vesting arrangement.

For instance, upon vesting shares, founders become the legal holder of shares to vote or receive dividends as the agreement of vesting deems fit.

Stock issued subject to a vesting schedule is called “restricted stock. For example:

Mr. Abram, the founder of Xentech, agrees to receive 10,000 shares which would vest over 4 years with the 12-month cliff.

This means that if Mr. Abram leaves within 12 months, zero shares would be vested, and after 1 year, shares would be vested proportionately.

Right of First Refusal

If founders need to exit the business by selling their shares in the company, founders’ stock can be imposed with the restriction that shares by all the shareholders would be only sold to existing founders first and then to external investors.

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This is basically to curb the outside influence and maintain the zeal of the founding members as long as possible.

The other common features include:

  1. Founders’ stock is a form of restricted stock. That may mean that after paying dividends to preference and ordinary shareholders, founders would be qualified to receive the dividends at last.
  2. F founders may have accelerated vesting options when the business is going down under the knife for sale or liquidation.
  3. Founders’ stock is the first issue of the company. When founders sell these, these are no longer founders’ stock in a literal sense, although they may have the same rights at the transfer time.

Vesting Schedule for Founders Stock

Founders’ stock comes with a vesting schedule. The schedule depicts the terms and conditions for shareholders to exercise their stock options.

The reason for vesting schedules is that it helps to protect the other founders from free-rider problems if one founder decides to leave early.

Another reason is to protect the founders from future investment from outsiders.

Allocation of Founders Stock

The stock should be allocated in layers. The uppermost layer always consists of the founders of the company, which forms the larger chunk. W

hen the company keeps growing, the employees and investor base keeps growing.