Founder's Stock - Explained

Summary:

Founder’s stocks are stocks awarded to the founders of a company during its establishment. They have certain different characteristics when compared to standard stocks. This blog outlines the basics of a founder’s stock and its significance.

When a company is established, a group of entrepreneurs who played a significant role in its founding- or the founders, are awarded shares of the company’s stock. Typically, these founders are individuals or a small group of entrepreneurs who actively participate in the company’s initial operations, provide, or arrange for the starting capital, and may even come up with the entire idea for the business. The stocks they receive are known as the Founder’s stock. Essentially, Founder’s stocks are common stocks, or a basic form of stock that every listed entity releases.

What are the key characteristics of Founder's stock?

Founder's stock indicates a stake of ownership in the company releasing the stock. At the origin of a company, the founders typically receive a significant portion of the company’s initial shares. It has some distinguishing characteristics, including:

• Special Rights: The stocks that founders receive often come with special privileges and rights that provide a degree of control over the company. These rights may include seats on the board, rights to vote, and specific preferences during the sale or the liquidation of the company.
• Vesting: Founder’s stocks are invariably subject to a vesting schedule. This means that even founders must wait for a specific period and may even have to meet some performance-based criteria to gain full ownership of their shares. This measure helps ensure their commitment to the long-term success of the company.
• Cliff and Vesting Period: This vesting period of the founder’s stocks may be further controlled by including a “cliff” period. During this cliff period, the shares do not vest and post the cliff period, the shares gradually become fully vested. This too helps in committing the founders to stick with the company, irrespective of the conditions.
• Restrictions on Transfer: For the founders, transferring or selling stocks can be more complex than usual. They may need the explicit consent of the company or other stakeholders if they wish to transfer or sell the shares. This, again, helps maintain a stable ownership structure.
• Purchase Price: Founder’s stocks are often allocated to the founders at a relatively low cost to help them acquire an initial equity stake. The value of these stocks is often called the “par value”. Initially, they are given out at a nominal purchase price to the founders.
• Long-Term Perspective: A founder's stock is typically associated with a long-term perspective. The intention of the founders here is to hold their shares for the duration of the company's growth and development. This aligns their interests with the company's long-term success.
• Tax Implications: Founders typically need to be aware of the tax implications that are associated with the founder’s stock. These often include potential capital gains taxes or ordinary income taxes when selling their shares.

The Importance of Founder’s Stock

Founder’s stocks are an essential component of the equity structure of any startup or a new company. These stocks are crucial indications of the commitment, risks, and contributions of the founders towards the company.

1. Alignment of Interests: The founder’s stock is important in aligning the interests of the company's founders with the long-term success of the business. When founders hold a substantial portion of the company's equity, there is enough motivation to work tirelessly to enhance the company’s value and achieve growth.
2. Control and Decision-Making: In many cases, the founder's stock equips founders with voting rights, giving them essential control over important decisions. This enables founders to guide the company's movements, provide protection against potential external influences, and most importantly, maintain its vision.
3. Attracting Talent: Founder's stocks are a great way to attract key talent to the startup. Offering equity as part of compensation is a powerful incentive for early employees who are ready to work for the company’s growth and steer it to success.
4. Raising Capital: This can also provide good leverage in securing investments from venture capitalists, angel investors, or other funding sources. When founders have a substantial stake in the company, it shows that they are committed and dedicated towards the company’s goals.

As the company grows and acquires additional funding from varied resources, the ownership structure evolves in tandem. This may lead to the influx of new investors who may be granted shares and potentially dilute the ownership stake of the founders. This makes it critical to negotiate carefully and structure the founder's stocks to align the long-term success of the company with the interests of the founders.

Conclusion

Founder's stock is best explained as the building blocks of startups as it represents the founders' commitment, vision, and dedication to their venture. The role of the founders in attracting investors, employees, and partners who are equally enthusiastic about the company's success is crucial for the company’s growth in the future. The founders must set up a fair and transparent system to ensure that their startup thrives while preserving their control and vision for the company's future. Founder’s stock thus remains a fundamental element that enables founders to influence the future of their startups.