Founder lock-up

Hello startup enthusiasts!

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Bad news? The vacation season is almost over. Good news? We’re back with a new edition of our newsletter in which we explain legal terms in a way your grandma would understand. Today, we’re highlighting another key investment term: founder lock-up. We bet you heard about it, but do you know why it’s so important for both founders and investors? Let’s get started.

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What’s a founder lock-up?

Founder lock-up provisions define a time period, usually 1-4 years, during which founders can’t sell their shares or leave the company. If a founder leaves before the so-called (reverse) vesting period is over, they lose a proportional part of their shares. A founder who leaves on good terms (a Good Leaver) can sell their shares for fair market value, or simply keeps the vested shares. The-so called Bad Leaver (a founder who breaches an important duty to the company) will either lose their shares or be forced to sell at a discount.

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Why does this matter?

Founder lock-up provisions are keep your company stable. They give investors a peace of mind that founders will stay on-board for the duration of the lock-up period. This is crucial because an early founder exit can literally rock the company boat - both internally (when we look at employee motivation) and externally (we’re talking credibility towards partners and customers). For founders, it gives them a clear road to “earning” their shares.

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Dos and dont’s

Here’s what to do and what to avoid:

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Dos

• understand the lock-up terms including reverse vesting
• align lock-up terms with your long-term goals
• consider negotiating early release if you hit a crucial milestone (e.g. certain ARR)

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Dont’s

• give up on negotiating the lock-up parameters
• accept personal guarantees beyond reverse vesting
• agree to overly long lock-up periods (over 4 years)

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In a nutshell

Founder lock-up provisions are all about stability. They give everyone transparency over how long founders stay on board, so that the whole company rallies behind growing the business. That’s why it’s something that shouldn’t be overlooked during investment term sheet negotiations. A balanced and fair founder lock-up provision can help the company sky-rocket, but a vague (or unfair) wording can tank it.

Want to chat more about founder lock-up or other investment-related topics? Reach out to our team for personalized advice and stay connected with us on LinkedIn for more insights.

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Until next time!

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