Founders Stock – Meaning, Features And Importance

Who are the Founders?

Those persons who establish the foundations of company or any forms of business are called founders. In more technical sense, they are the initial stockholders of the companies. They put in their sweat to incorporate the company. They took the decision to convert their idea into formation of 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 depict shares of common stock issued as per the consent of board of directors. When the company is organized at the beginning, the important documents are executed for incorporation that includes 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 large percentage of stock given to individual founders. The stocks are issued at nominal price. At the incorporation, the company usually issues stock at 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, following are the points to be noted:

Power of Control

The problem among newly established business i.e. startups are losing control over the course of success of business. This is due to raising of more funds through equity. After some time, founders no longer controls the company business entirely due to new investors coming in like joint ventures, angel investors and private equity.

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However, to retain control, founders specify 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 to founders to hire more than one or two directors in 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

If a co-founder leaves the company say due to exit by incoming investors or retirement or pursue other paths, this can lead to complicated situations, if co-founder has large holdings. In start-up terms, this gives rise to “free rider” problem. This means that co-founder will be heavily benefitted if company succeeds without him taking much risk and sweat for the success.

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

Taking for instance, upon vesting of shares, founders become 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 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

In the event of founders’ need to exit the business by selling the shares of the company, founders’ stock can be imposed with restriction that shares by all the shareholders would be only sold to existing founders’ first and then to external investors. This is basically to curb the outside influence and maintain the zeal of the founding members as long as possible.

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The other common features include:

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

Vesting Schedule for Founders Stock

Founders stock come with vesting schedule. The schedule depicts the terms and conditions when shareholders would be allowed to exercise their stock options. The reason for vesting schedules are that it helps to protect the other founders from free rider problem if one a 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 founders of the company which forms the larger chunk. When the company keeps growing, the employees and investor base keeps growing.

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