Reverse vesting: key considerations when preparing a reverse vesting agreement

‘Vesting’ is a common term used when referring to the process by which an individual gradually receives their shares in a company over a set period of time. The key commercial incentive for business owners to use this approach is that it both protects them from potentially diluting their share of ownership in favour of unproven new shareholders whilst at the same time incentivising key individuals to commit to the growth and success of the company by ultimately being rewarded with ownership.

What is a reverse vesting arrangement?

As the name would imply, reverse vesting is the opposite of vesting as shares are issued in full to an individual upfront, but the company retains the right to reclaim a proportion of these shares if the individual is deemed to have departed from the business prematurely. Such shares will usually be repurchased at no profit to the shareholder in question, and the relevant proportion exposed to this right of re-purchase will decrease over time. This arrangement could, for example, be requested by an outside investor who, in return for their financial commitment into a new business, wants to ensure that a founder, who understandably commands a meaningful stake in their business, demonstrates that their shareholding from the outset is justified and cannot walk away with a significant portion of equity without fulfilling their commitments. In order to secure their full shareholding free from this right of re-purchase, an individual will have to earn this right over a period of time (known as the vesting period) by adhering to certain provisions set out in a reverse vesting agreement.

Preparing a reverse vesting agreement

When preparing a reverse vesting agreement, parties will need to take into account the following aspects: 

The vesting schedule – this schedule determines how the shares become fully owned over time. As mentioned above, there will be a vesting period of around 3-5 years. It’s also possible to introduce a 1-year cliff period where if the individual leaves in that 1-year period, no shares will have been vested. The agreement will also need to specify whether shares are vested on a monthly, quarterly or annual basis.

Exit considerations – the agreement should define what happens to unvested shares in various ‘exit’ scenarios. If the individual resigns, it is typical for these shares to be forfeited and repurchased by the company. If there is a termination for cause, the unvested shares can be forfeited, and any vested shares could also be bought back at nominal value by the company. If there is a termination without cause, it is common that some or all of the unvested shares can be vested immediately. 

Buyback terms – the agreement should also outline how the unvested shares can be bought back by the company. It is possible to set out in the agreement that the unvested shares can be bought back at a nominal value but of course at all times in compliance with the buy-back rules under UK company law.

Shareholder rights – the agreement should set out the rights attached to the unvested shares i.e. should they have voting rights, the right to dividends and any transfer restrictions etc.

Performance considerations – the vesting agreement will also need to specify certain performance considerations of the individual such as work hours, KPIs, breach of contractual obligations and what will happen to the unvested shares if those aren’t met.

Accelerated vesting – in the event there is an acquisition, merger or IPO, the agreement should take into consideration whether all unvested shares may vest immediately to reward that individual during an exit event. 

Tax implications – before deciding whether to go down the route of reverse vesting, it’s imperative that parties seek advice from a tax specialist as there will be certain tax implications. Failure to address this early on could lead to costly consequences for both the company and the individual.

Conclusion

Reverse vesting arrangements can be an effective tool to encourage commitment and protection of a company’s equity. However, it will require careful planning to balance the interests of the company, the members, and the investors.

If you or your business has any corporate matters you would like some advice on, please contact our corporate team by email on [email protected].