Founder vesting in Chile: how to structure it in an SpA so it survives a funding round

Vesting means that a founder consolidates the right to keep his or her shares over a period, normally tied to remaining in the company. In the jurisdictions where the model was born, shares can be issued subject to forfeiture. In Chile the SpA issues shares to a person who becomes their owner on subscribing them and is recorded as such in the shareholders register of Article 431 of the Commercial Code. Unless the bylaws provide otherwise, shares whose value is not fully paid carry no rights at all, and if the subscription is not paid within the term the capital is reduced to the amount actually paid (Article 434). Beyond that, the regime does not contemplate shares that are lost because their holder leaves. That is why vesting is built as an obligation of the founder: to sell the unvested shares, at the agreed price, if a defined event occurs, normally leaving the company before the schedule ends.

Practice builds that obligation in two ways. The first is a promise to sell or a purchase option in favor of the other founders or of the company, written in the shareholders agreement: a private contract among founders, and later with the investors, under which the departing founder is obliged to sell the unvested shares to the others or to the company. The second is in the bylaws: the bylaws themselves provide that, under defined circumstances, a shareholder may be required to sell his or her shares, and usually place the founders’ shares in a series of their own so that the burden falls on them and not on the investor’s shares. Both are lawful; they differ in whom they bind, in their publicity and in how they are amended.

A promise to enter into a contract produces no obligation at all unless the four requirements of Article 1554 of the Civil Code concur:

1. that the promise be in writing;
2. that the promised contract not be one of those the law declares ineffective;
3. that it contain a term or condition fixing the time for entering into the contract;
4. that it specify the promised contract in such a way that, for it to be perfected, only the delivery of the thing or the legal formalities are missing.

A vesting promise meets them if it identifies the shares, the price or its formula, the buyer, the condition that gives rise to the sale (the founder’s departure) and the term for entering into it once that condition occurs. That departure is a condition in the sense of Article 1473, a future event that may or may not happen, and a suspensive one under Article 1479: the obligation to sell arises only when it occurs. It is valid even though it depends on the founder’s decision, because it consists of a voluntary act of the founder (Article 1478, second paragraph).

Once the requirements of the promise and of the condition are met, the weak point of this route lies in its reach: the agreement binds only those who sign it. A new investor, an executive who receives shares later or a buyer of a founder’s stake are bound only if they adhere, and that is why every round reopens the agreement. An agreement on the transfer of shares must also be deposited with the company, available to the other shareholders and interested third parties, and referenced in the shareholders register; without that deposit it is unenforceable against third parties (Article 14, second paragraph, of Law 18.046, applicable to the SpA through Article 424 of the Commercial Code). Even when deposited, the agreement does not prevent the company from recording the transfers submitted to it.

The rest of the agreement (transfer restrictions, first offer, tag along and drag along) is covered in shareholders agreement.

• Freedom of the bylaws. Article 424 allows the bylaws to set the rights and obligations of the shareholders and the other covenants freely established, except where Paragraph 8 itself provides otherwise. What the bylaws do not regulate is decided first by that Paragraph and, only where both are silent, by the rules of the closed corporation (sociedad anónima cerrada), insofar as they do not conflict with the nature of the SpA.
• The forced-sale clause. Article 435 allows the bylaws to provide that, under defined circumstances, all or some of the shareholders may be required to sell their shares, in favor of another shareholder, of the company or of third parties. The same article requires the bylaws to regulate the effects and to establish the obligations and rights that arise for the shareholders; if they do not, the clause is deemed not written. That is why the triggering event, the price or its formula, the term and the procedure should appear in the bylaws themselves: without them it is hard to maintain that they regulate the rights and obligations the rule demands.
• Series of shares. Article 436 allows the bylaws to create series with burdens, obligations, privileges or special rights established precisely, and Article 437 admits series with limited, multiple or no vote. Placing the founders’ shares in a series allows the vesting burden to fall only on them.
• The company as buyer. Article 438 allows the SpA to acquire shares of its own issue unless the bylaws prohibit it. While it holds them, those shares do not count for the quorum and carry no vote, dividend or preference in the subscription of capital increases, and the company has to dispose of them within the term the bylaws set or, if they are silent, within one year of the acquisition; otherwise the capital is reduced by operation of law and the shares are removed from the register. Purchase by the company serves to retain the unvested shares and reassign them within that term to another founder or to an incentive plan. If the aim is to cancel them, Article 440 requires the capital reduction to be resolved beforehand, by the majority the bylaws set or, if they are silent, unanimously, and the company may acquire the shares only once that amendment is perfected.
• Register and arbitration. Every transfer is recorded in the shareholders register of Article 431, and the transferee declares, under Article 446, that he or she knows the legal rules, the bylaws and the protections that may or may not exist in them. Disputes among shareholders, and between them and the company, go, as a general rule, to mandatory arbitration under Article 441, on the terms the bylaws set.

Many companies that reach a priced round combine the two layers. The bylaws contain the forced-sale clause and the founders’ series, with the triggering event, the schedule that determines how many shares it reaches, the price or its formula, the term and the procedure, because Article 435 requires them to regulate the effects and the rights and obligations that arise, on pain of being deemed not written. The agreement adds the operational detail that is better not published, provided it is not the detail the bylaw clause needs in order to work.

• Waiting period and schedule. Market practice, taken from US venture capital contracts, is a cliff (an initial period in which no share vests) of one year within a schedule of three or four years that vests monthly or quarterly after the cliff. Both terms are market usage; a founder with prior work in the company usually negotiates credit for it.
• Acceleration on change of control. The clause defines whether the sale of the company vests everything at once (single trigger) or only when, in addition, the founder is dismissed after the sale (double trigger). Investors and buyers prefer the double trigger; founders, the single one.
• Good leaver and bad leaver. The clause classifies each departure: those in which the founder keeps the vested shares, or sells them at fair value if so agreed (death, incapacity, dismissal without cause), and those in which the founder is obliged to sell them at par or paid-in value (resignation before the cliff, breach, competition). Extending the mandatory sale to shares already vested is an additional burden that the clause has to agree expressly. Disputes over departures generally arise from vague definitions.
• Purchase price. The usual approach is par or paid-in value for the unvested shares and an agreed formula or valuation for the vested ones. Article 435 requires the bylaws to regulate the rights and obligations arising from the forced sale, and the price is the first that will be disputed. Article 1554 requires the promise to specify the promised contract, and the price forms part of that specification.
• Destination of the shares. Pro rata redistribution among the remaining founders keeps the capitalization table simple. Purchase by the company is subject to Article 438: resale or reassignment within the bylaw term or within one year; otherwise, reduction of capital by operation of law. Cancelling them deliberately requires the prior capital reduction of Article 440.
• The founder’s employment relationship. Founders are usually also employees or managers. If vesting is drafted as part of the remuneration for services rendered under an employment contract, the rules on remuneration of the Labor Code (Código del Trabajo) may reach it; the clause has to rest on the shareholder relationship and not on the employment one.
• Taxes. The treatment of the transfer for the founder, the buyers and the company depends on how it is structured and on the price. Sales at par value and incentive plans have tax effects of their own, which should be reviewed in each case before signing.

In our experience, a priced round rarely closes without vesting, and an investor who does not find it proposes his or her own terms. Founders who agree it at incorporation, in the bylaws and in the agreement, negotiate from a stronger position: they can ask for credit for the time elapsed, acceleration on a change of control and a cliff already completed. The choice of vehicle comes first, and it is the SpA that admits series and forced-sale clauses, as explained in SpA or Limitada?. The financing instrument and its conversion into shares are compared in SAFE or convertible note, and the round as a whole in Venture Capital.