The most important facts in brief:
- Vesting clauses regulate when founders and employees are finally entitled to shares in the company.
- There are two types of vesting clauses, one for founders, when they may sell their shares, and the other for employees who save up shares in the company.
- Vesting clauses for founders require precise regulations, otherwise the vesting clause may be invalid.
What is a vesting clause?
Vesting clauses regulate when founders and employees are finally entitled to shares in the company. Vesting means "release" in German. There are two types of vesting clauses that need to be distinguished:
- ReleaseWhen investors buy into a company and the company founders continue to hold a stake in the company, the investors want to prevent the founders from selling their shares immediately and no longer working for the company. Vesting clauses therefore stipulate in this case that the founders can only sell their shares to third parties after a fixed period of time, thus creating an incentive to work for the company in the long term.
- SavingsVesting clauses are also used for employee shares. In contrast to founders, employees do not yet have a stake in the company. The vesting clause therefore regulates the time during which employees "save up" their shareholding in their employer.
How is a vesting clause for founders structured?
Legally, there are several ways of structuring vesting clauses. In practice, the most common form is a call option. However, all forms have their advantages and disadvantages, meaning that a decision must be made on a case-by-case basis as to how the vesting clause should be structured. The following forms are generally possible:
- Call optionThe founders submit an irrevocable offer to sell and transfer certain shares to the remaining shareholders. The exact date and conditions by which the option can be exercised are specified. When concluding the contract, the parties must bear in mind that the conclusion of the call option generally requires notarization.
- Withdrawal clauseThere is the option of redeeming the shares if certain conditions are met, e.g. termination. This type of arrangement is rarely used in practice, as the shares would be destroyed.
What provisions does a vesting clause contain for founders?
For a vesting clause to meet the interests of the parties, it is necessary to specifically agree in which case the vesting clause applies and what rights and obligations exist when it is exercised. The following points should be regulated in a vesting clause:
- Acquisition right of the investorThe central point of a vesting clause, especially when structured as a call option, is the investors' right to purchase. It must be stipulated in which case the acquisition right exists and which person is entitled to the acquisition right.
- Deadline: The period within which the right can be exercised from the date of knowledge of the departure must be specified.
- Melting timeIn most cases, the shares are released successively. This means that a few units are released each year. Shares are usually released over a period of 4 years. A common rule is that 1/48 of the shares are released each month and are irrevocably transferred to the founder. In the first 12 months, however, no shares are usually released at all, so that after 12 months a lump sum of 12/48 is released and then a further 1/48 each month.
- Severance paymentIf the call option is exercised or the shares are redeemed, the founders receive compensation. The amount of compensation depends on the reason for terminating the contract. If the founder is in breach of duty, the compensation is lower than if the company terminates the contract for operational reasons (so-called "termination for cause"). Good leaver vs. bad leaver).
- Voting rightsEven in the event that the shares are not sold or redeemed but the founder nevertheless leaves the company, provisions are made. A popular provision is that the founder's voting rights may not be exercised from the time of departure until the exit (e.g. the sale of the company).
The content of a vesting agreement is often shaped by investors. Investors want to secure their investment with the vesting agreement and ensure that the founders continue to work for the company. In order for the vesting clause to be effective, the following aspects must be taken into account:
- ImmoralityWhen drafting a vesting clause, care must be taken to ensure that the clauses are not immoral, Section 138 (1) BGB. A clause is immoral if a shareholder can be excluded from the company by other shareholders or a group of shareholders without objective reason. Some argue that this standard also applies to vesting clauses. So far, this case law has not been answered, so there is a risk that the standard is applicable. Accordingly, the call option or redemption should be structured in such a way that an objective reason is required for exercising it.
- DeterminationIn particular, if the vesting clause is structured as a call option, the principle of certainty must be observed. It must be precisely stipulated which specific shares are to be purchased when the option is exercised and which shares are already firmly held by the managing director.
Vesting clause for employee shares
Another use case for vesting clauses is employee shares. In contrast to the founders, employees have no shares in the company when they are hired. In order to increase loyalty to the company, employees are often given a stake in the company. Employees usually do not receive their shares all at once, but "save up" the shares gradually. The clause that regulates the savings period for employee participation is known as a vesting clause.
In terms of content, the vesting clause for employee shares has many similarities with a vesting clause for founders. The following special features apply to vesting clauses for employees:
- CliffMany employees only receive employee shares after a certain period of time. For example, it is often necessary to work for the company for at least 12 months in order to receive shares as an employee. This waiting period is known as the "cliff".
- Accelerated vestingEmployees are usually given the opportunity to build up their shareholding in the employer over several years. If the company is sold during this savings period, it can be agreed that the employee receives the full shareholding early.
Employee shares are often structured virtually. This means that employees do not receive shares in their employer, but instead conclude a contract with their employer that equates the employees to a shareholder under the law of obligations. Such agreements require extensive contracts in order to precisely agree the rights and obligations.