पाठशाला Pathshala · दल Dal, The team · Lesson 02 · Start

Vesting and the co-founder cliff

Vesting is the clause co-founders skip because they trust each other. It exists for the day one of them leaves. The standard schedule, the acceleration terms to refuse, and how Indian ESOP rules actually work.

Pathshala, The Founder Library · 10 October 2026 · 9 min read

Two friends split a company fifty-fifty in a café in Koramangala. Fourteen months later one of them takes a job. Nobody did anything wrong, and the company is now half owned by someone who does not work there, which means it is not fundable, not hireable and not fixable without a lawyer and a fight. Vesting is the clause that was skipped because the friends trusted each other. It is also the clause that would have protected the friendship.

This lesson covers what vesting is, the standard schedule and why it has the shape it does, the acceleration terms to accept and refuse, how founder vesting is implemented in India where the shares already exist, and how employee options are governed by the Companies Act and taxed, including the 2020 deferral for recognised startups.

What vesting is, and whom it protects

Vesting means equity is earned over a period rather than owned outright on the first day. A founder on a four-year schedule who leaves after two years keeps half the grant; the other half goes back to the company or the remaining founders. Brad Feld’s 2005 note on vesting in the term sheet states the industry standard that still holds: a one-year cliff and monthly thereafter for a total of four years.

Founders tend to experience vesting as something investors impose, and investors do insist on it. But Feld’s point is that it protects the founders from each other: with each founder vesting, there is a clear incentive to work hard and participate constructively, and without it a founder who does not work out can leave with all of their stock. The honest framing is this: the question is not whether you trust your co-founder today. It is what the company looks like if one of you is gone in eighteen months, which, across enough companies, one of you will be.

Why this shape? Four years, because that is roughly how long it takes a company to become something; a founder who leaves earlier has not finished the job the equity was for. A one-year cliff, because the first year is when it becomes clear whether a partnership works, and a company cannot afford to pay equity for the experiment; Index Ventures’ handbook puts it as giving companies time to weed out mis-hires without suffering dilution. Leave before the one-year mark and nothing has vested; the unvested equity goes back to the company or the pool. At the cliff a quarter vests at once. From month thirteen, one forty-eighth vests each month, so that by month twenty-four half is earned, by month thirty-six three quarters, and at month forty-eight all of it.

Monthly rather than annually after the cliff matters more than it looks. Index Ventures’ Rewarding Talent notes that in the United States vesting is almost always monthly after the cliff, while in Europe it is often quarterly or annual to reduce administration. Annual vesting creates a cliff every year, and a founder in month thirty-five of an annual schedule has a reason to stay one more month and then leave. Monthly removes the cliff-edge incentive after year one. Insist on it.

Acceleration: single trigger, double trigger

Acceleration is what happens to unvested equity when the company is sold. Feld defines single trigger as automatic accelerated vesting on a merger, and double trigger as two events needing to take place before vesting accelerates: in practice the sale, and then the founder being dismissed without cause by the acquirer within some period after it. He observes that double trigger is much more common than single, that some investors will never do a deal with single-trigger acceleration, and recommends a balanced position of double trigger with one year of acceleration.

Index Ventures’ guide to change of control provisions explains why acquirers dislike single trigger: acceleration without a double trigger reduces the sale proceeds for every ordinary shareholder and deters buyers, because the team is often the most valuable thing being bought and people who receive an unexpected payout at closing are more likely to leave. Index’s own recommendation is at most double-trigger partial acceleration, limited to the executive team. For a founder, the position to hold is double trigger with twelve months of acceleration, or full acceleration on termination without cause after a sale. Single trigger will cost you in the price of the company and may cost you the sale.

Reverse vesting: how founders are vested in India

A founder’s shares in an Indian private limited company are issued at incorporation and are fully owned from day one. Vesting therefore cannot be done the way an option grant is; it is done in reverse, by contract. The founders’ agreement, and later the shareholders’ agreement with investors, provides that a defined portion of each founder’s shares is treated as unvested on the schedule, and that if a founder leaves before the end of it the company or the remaining founders have the right to acquire the unvested shares at par, or at the price originally paid. Whether that right is exercised as a transfer to the other founders, to a nominee or through a buy-back is a drafting decision for your lawyer, because the Companies Act restricts the ways in which a company may buy its own shares. The economic effect is the same as forward vesting: leave early, lose the unvested portion.

Two terms do most of the work in these clauses. Good leaver and bad leaver decide what happens to vested shares as well as unvested: a founder who is dismissed for cause or who breaches the agreement may be made to sell vested shares at a discount, while one who leaves for illness or by agreement keeps what has vested. Define cause narrowly and in writing. Acceleration for founders should be negotiated in the shareholders’ agreement at the first institutional round, not later; after that round the schedule is often restarted or extended, and a founder who has been building for two years without a vesting agreement should ask for credit for that time rather than accept a fresh four years.

Vesting is not a statement about trust. It is a statement about what the company is worth if trust turns out to have been misplaced.

Employee options under the Companies Act

Employee stock options are a different instrument from founder shares and are governed by section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. The rules a founder should know: the scheme needs shareholder approval, by special resolution in the rule as written, although private companies have been permitted since the June 2015 exemption notification to approve it by ordinary resolution; there must be a minimum of one year between the grant of options and vesting, so a cliff shorter than twelve months is not available; option holders have no right to dividends or votes until they exercise and shares are issued; and the company may specify a lock-in on shares issued on exercise.

The rule that surprises founders is the exclusion. Rule 12 excludes from the definition of employee anyone who is a promoter or belongs to the promoter group, and any director who holds, directly or indirectly, more than ten per cent of the equity. A proviso inserted in 2016 lifts both exclusions for a start-up company, meaning one recognised under the DPIIT notification, for a period that an August 2019 amendment extended from five to ten years from incorporation. So a recognised startup may grant options to its founders in its first decade; a company that is not recognised, or is older than that, may not.

How options are taxed, and the 2020 deferral

Options are taxed twice in India, at two different times. At exercise, the difference between the fair market value of the shares on the exercise date and the price the employee pays is a perquisite under section 17(2)(vi) of the Income-tax Act, taxed as salary and subject to TDS by the employer; the Income Tax Department’s note on ESOP taxation sets this out. On sale, the gain over that fair market value is a capital gain, with the FMV at exercise treated as the cost of acquisition. The problem this creates for startup employees is obvious: tax is due in cash at exercise, on shares that cannot be sold.

The Union Budget of February 2020 addressed it for one class of company. The Finance Bill 2020 memorandum inserted sub-section (1C) into section 192, with matching changes to sections 191, 156 and 140A, so that an eligible start-up under section 80-IAC deducts or pays the tax on the ESOP perquisite within fourteen days of the earliest of three events: the expiry of forty-eight months from the end of the relevant assessment year, the sale of the shares, or the employee leaving the company. The tax is computed at the rates for the year the shares were allotted. The change took effect from 1 April 2020.

Read the qualifier carefully. The deferral applies to eligible start-ups under section 80-IAC, which is a narrower set than DPIIT recognition: it requires approval by the Inter-Ministerial Board, a turnover not exceeding ₹100 crore, and incorporation before 1 April 2030 after the extension announced in the Union Budget 2025–26; DPIIT reported in May 2025 that just over 3,700 startups had received the exemption since the scheme began, a small fraction of the companies DPIIT has recognised. A DPIIT-recognised company that has not obtained the 80-IAC certificate still withholds tax at exercise in the ordinary way. If you intend to use options to hire, obtaining the certificate is part of setting up the plan.

A worked example

Three founders in Gurugram split a company equally, 33.3 per cent each, with a four-year, one-year-cliff reverse vesting agreement signed at incorporation. In month eight one founder leaves to take a job. Under the agreement all of her shares are unvested and are acquired at par by the other two, who now hold 50 per cent each. The company remains fundable. Had she left in month twenty, 20 of 48 months would have vested: she keeps 41.7 per cent of her grant, about 13.9 per cent of the company, and the two remaining founders acquire the rest. An investor arriving at month twenty-four sees a cap table in which the people doing the work own the company, and a departed founder with a defensible minority, and has no reason to make the vesting a condition of the term sheet.

Without the agreement, the same departure at month eight leaves a 33.3 per cent shareholder who does not work there. Any investor will require that holding to be bought down before investing. The departed founder now has every incentive to hold out, and the price of the buy-back is set by that incentive, not by what the shares were worth. The company spends its first fundraising on fixing its own cap table.

What to check before you sign anything

The schedule is four years, one-year cliff, monthly after. Anything longer or with annual steps needs a reason. Credit for time already served if the agreement is being signed after the work started. Acceleration is double trigger, with the period and the definition of good reason written down. Good leaver and bad leaver are defined, and cause is narrow. The mechanism for unvested shares is specified, with price and counterparty, by a lawyer who has done it under the Companies Act. The ESOP scheme follows Rule 12: shareholder approval, the one-year minimum, and, if founders are to receive options, confirmation that the company is a recognised startup within ten years of incorporation. 80-IAC status is applied for if the tax deferral matters to your hiring.

Do it in the first month, while everyone still likes each other. Then put a reminder for the cliff date in every founder’s calendar, because the month before the cliff is the month in which the conversation about whether this is working should be had, deliberately, rather than discovered.

None of this is legal or tax advice. Rules and rates change, the Companies Act is particular about how a company deals in its own shares, and a lawyer who has drafted Indian founders’ agreements and ESOP schemes is the cheapest part of this process.