Definition of Founder’s Stock
As the name suggests, founder’s stock is the name for stock that’s given to the founder and co-founders of an organisation. However, it’s not purely limited to the founders and can also be given to investors, mentors and any other early aides and employees that help to take the company from concept to reality.
In some cases, founder’s stock is also allocated to employees who provide the company with their intellectual property.
Founder’s stock differs from regular stock in that it can only be issued at face value and includes a vesting schedule. The purpose of this schedule is to identify when the shareholders can exercise their stock options. If shares are vested over two years, it means that the employee needs to work for the company for those two years before they’re able to exercise their stocks.
Vesting schedules have a number of advantages, most notably that they stop people from joining the company, claiming their shares and then leaving the company. It also means that if one of the company’s founding members parts ways with the team, they don’t stand to benefit from the hard work of the remaining members.
Even if the founders themselves don’t insist on a vesting schedule, it’s not uncommon for investors to ask them to implement them. The shares themselves are often sold for a nominal amount, such as $0.01 per share, and the number of shares available is often based on either seniority or the amount of money that they invested.
One of the appealing aspects of preferred stock is that it often has a high priority claim on a company’s assets. This means that if the company goes bankrupt, goes through a merger or is sold, preferred shareholders get their investment back and a return before anything goes towards the common stockholders.
Are there any tax considerations for founder’s stock?
It’s usually a good idea to incorporate a company and to issue founder’s stock as early as possible. That’s because if investors come along later and pay a higher price for their shares, government audits may determine that the founders issued stock to themselves at far below the fair value. The founders might then be liable to pay tax on the difference between what they paid for their shares and what their investors paid for theirs.
This can often be avoided if founders remember to file an 83(b) election form within 30 days of buying the shares and to pay taxes early. The problem is that most founders don’t do this.
What are some of the common rights and restrictions for founder’s stock?
Founders stock often includes rights and restrictions that can include:
- Rights of first refusal, designed to push founders to first offer them to the company or other shareholders without transferring them elsewhere
- Changing vesting rules such as an acceleration if the company is sold or control passes to someone else
- Clauses in place to stop founders’ share positions from being diluted
- Enhanced voting rights
- Lock-up agreements
