Legal
Equity is often part of the early startup bargain. Founders use it to bring in co-founders, senior hires, advisors and early employees when cash is limited and the company is still proving itself. Done well, equity gives people a real stake in the value they are helping to build.
The risk is not offering equity. The risk is offering it before the rules are clear.
Who earns it? When does it vest? What happens if the person leaves? Has the board approved it? Does the cap table match the company records? Has anyone checked the tax position? These details can feel administrative at the time. They become much more important when the company is preparing for a raise, updating its ESOP, answering investor questions or cleaning up the cap table before an exit.
Vesting is what stops equity from becoming an open-ended promise. It sets out how shares, options or equity rights are earned over time, or when agreed milestones are met. It keeps ownership tied to contribution and gives the company a cleaner story to explain to employees, founders and investors.
For founders, vesting is not just a legal term buried in documents. It is part of keeping the company investable.
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What equity vesting means
Equity vesting means someone earns their equity over time, or when specific conditions are met. They do not receive the full benefit upfront.
For example, an employee might receive options that vest over four years. If they leave after two years, they may only keep the portion that has vested. The unvested portion is usually cancelled or returned to the company’s option pool, depending on the plan rules.
Vesting is commonly used for founders, employees, advisors, contractors, senior executives and early contributors. The basic idea is simple: equity should usually be earned, not handed over all at once.
What matters is that the company can explain the arrangement clearly:
- who has equity
- why they received it
- how it vests
- what happens if they leave
- where the arrangement is documented
A promise in an email, Slack message or side conversation is not enough if the formal records say something different. That gap can create problems later, especially when the cap table, company register and ESOP documents need to line up. LUNA has written more about why the company register matters before a raise, ESOP update or exit.
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Why vesting matters
In an early-stage company, every percentage point matters. Once equity is issued, promised or allocated, it affects the ownership structure of the company. It also affects what is left for future hires, investors and founders.
A founder who leaves early but keeps a large stake can create tension for the remaining team. An advisor with unclear equity terms can create a messy conversation months later. An employee option grant that was promised but not documented can slow down due diligence. Investors do not expect every early decision to be perfect. They do expect the company to know what has been promised, what has been approved and what is still outstanding.
Messy vesting usually does not kill a raise on its own, but it does create friction. It can make investors ask whether the same issue exists elsewhere: undocumented promises, weak approvals, missing records, unclear leaver terms or a cap table that does not match the legal documents. That is why vesting should be treated as part of company governance, not just an employee incentive detail.
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Time-based and milestone-based vesting
Most startup vesting falls into two categories.
Time-based vesting means equity is earned over a set period. A common structure is four years, often with a one-year cliff.
A one-year cliff means the person needs to stay with the company for 12 months before any equity vests. After that, the remaining equity usually vests monthly, quarterly or annually over the rest of the vesting period.
For example:
- If someone leaves after six months, no options have vested.
- If they stay for one year, 25 per cent may vest.
- The remaining 75 per cent may vest over the next three years.
Milestone-based vesting ties equity to a specific outcome instead of time served.
This can work well for an advisor helping close a funding round, a contractor delivering a product build, or a commercial lead signing a key customer. The risk is vague wording.
“Help grow revenue” is too loose.
“Secure $500,000 in signed annual recurring revenue from new enterprise customers by 30 June” is much easier to assess.
The company should be able to look back and say whether the milestone was met. If that answer needs a debate, the milestone was not clear enough.
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Founder vesting
Founder vesting is often the equity issue founders least expect to need. It is easy to assume vesting is only for employees. In a company with more than one founder, that assumption can create problems. If one founder leaves early but keeps a large shareholding, the remaining founder or founders may be left building the business while a departed founder still owns a meaningful stake. That can affect morale, hiring, fundraising and future negotiations.
Founder vesting is often handled through reverse vesting. Under reverse vesting, the founder may already hold the shares, but the company has a right to buy back some of those shares if the founder leaves before the vesting period is complete. The point is not to punish a departing founder. It is to make sure founder ownership reflects ongoing involvement in the company. Founder vesting should be checked against the shareholders’ agreement, company constitution, cap table and company register. If those documents do not tell the same story, the issue may need to be fixed before a raise.
For founders preparing for investor review, LUNA’s guide to financial due diligence before raising capital is a useful related read.
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Employee equity and ESOP vesting
Employee equity is usually managed through an employee share option plan, often called an ESOP. An ESOP allows employees to receive options or rights to acquire shares in the company. Those options usually vest over time, often with a cliff.
For employees, the vesting schedule affects how much equity they can keep if they leave. For founders, the vesting schedule protects the option pool and reduces the risk of giving away equity before it has been earned.
Before offering employee equity, the company should be clear on:
- the vesting period
- the cliff period
- what happens when someone leaves
- how long someone has to exercise vested options
- what happens to unvested options
- board approval requirements
- tax treatment
- good leaver and bad leaver rules
- what happens on a sale or exit
These rules should sit in the formal ESOP documents, not just in an email, offer letter or side conversation. LUNA’s legal services for startups and scaleups include employee incentives, ESOPs, founder and shareholder agreements, capital raising and governance support.
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Why vesting matters before a raise
Vesting often becomes urgent when a startup prepares to raise. Investors will usually want to understand who owns equity in the company, how that equity was issued and whether the arrangements are properly documented.
They may review founder vesting arrangements, employee option grants, advisor equity, the option pool, vested and unvested equity, board approvals, shareholder approvals, company register records, ESOP documents and any undocumented promises. Sometimes the underlying issue is small. The bigger problem is that the records do not clearly explain what happened.
Before raising, founders should make sure the cap table, company register, ESOP records and equity documents all tell the same story. This sits alongside the broader finance and governance work founders should do before raising. LUNA’s guide to financial controls startups need before Series A covers the finance side of that preparation, including runway, hiring, revenue quality, board reporting and due diligence.
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Common vesting mistakes
Most vesting problems come from moving quickly and documenting too little.
Common issues include:
- issuing equity without a vesting schedule
- promising equity before documents are ready
- using vague milestone-based vesting terms
- failing to document founder vesting properly
- not explaining vesting clearly to employees
- leaving ESOP documents incomplete or outdated
- not tracking vested and unvested equity properly
- creating side arrangements outside the formal documents
- failing to update the cap table after equity changes
- not considering tax before issuing equity
These issues usually appear at the worst time: during a raise, exit, founder dispute or senior employee departure. The cleanest approach is to document the arrangement before the person starts relying on it.
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What founders should check before issuing equity
Before issuing or promising equity, founders should slow down and check the basics.
The reason for the equity
The company should know what contribution the equity is designed to reward. Employment, advisory support, founder commitment, commercial outcomes and project delivery are not the same thing.
The type of equity
The recipient may receive shares, options or another form of equity right. The right structure depends on the person, the purpose and the tax position.
The vesting terms
The company should document the vesting period, any cliff, whether vesting is time-based or milestone-based, and what happens if the person leaves.
The approvals
Depending on the structure, the company may need board approvals, shareholder approvals, cap table updates or company register updates.
The tax position
Tax should be considered before equity is issued, not after. Equity can create tax consequences for the company and the person receiving it. LUNA’s startup tax services can support founders working through equity, ESOP and scaling-related tax questions.
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Getting vesting right
Vesting is not about making equity harder to earn. It is about making the deal clear before everyone starts relying on it. For employees and advisors, that means knowing what they need to do to earn their equity. For founders, it means protecting the company from avoidable cap table and governance issues. For investors, it means the company can explain its ownership position without needing to reconstruct years of informal promises.
The best structures are not necessarily complex. They are clear, documented and understood by everyone involved. The commercial deal, legal documents, cap table and company records need to match. That is the part founders should not leave until due diligence.
LUNA works with startups and scaleups on equity, ESOPs, founder arrangements, company registers, tax and fundraising readiness. If you are issuing equity, preparing for a raise or cleaning up your cap table, our team can help you get the structure and documents right before they become a problem.
Explore LUNA’s legal services for startups and scaleups, startup tax support, scaleup services, or get in touch with the team.
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