If you're setting up a startup with co-founders, or thinking about giving equity to early employees, you'll hear the word "vesting" quickly. Most people have a rough idea of what it means: you earn your shares over time. But the way it actually works in Australian startups is different from what most founders expect, and the details matter.
This post explains how vesting works, how it's implemented in Australian shareholders agreements and employee share plans, and what to watch out for.
What vesting means
Vesting is the process by which a founder or employee earns the full benefit of their equity over time, subject to continued involvement in the business. The idea is straightforward: if a co-founder leaves six months in, they shouldn't walk away with the same equity stake as someone who stayed for four years and built the business.
Vesting creates a structure that ties equity to contribution.
How vesting actually works in Australian shareholders agreements
This is where founders are often surprised. The common assumption is that unvested shares are held back and issued progressively as they vest. In Australian practice, that's not typically how it works.
The more common structure is that all shares are issued to the co-founder upfront. They are the legal owner from day one. But the shareholders agreement includes a mandatory buy-back mechanism: if the co-founder leaves before their shares have vested, the company has the right to buy back the unvested portion at a price specified in the agreement.
The vesting schedule operates through the buy-back right. As time passes and shares vest, the pool of shares subject to potential buy-back shrinks. By the time a founder is fully vested, there is nothing left for the company to buy back.
This structure has practical consequences. Because shares are issued from the outset, the co-founder may need to pay for them at the time of issue (usually at a nominal price at incorporation). It also means the co-founder is a registered shareholder immediately, with all the voting and information rights that come with that.
Vesting schedules
The most common structure in Australian startups is a four-year vesting schedule with a one-year cliff. No shares vest in the first year. At the one-year mark, 25% vest at once. The remaining 75% then vest monthly or quarterly over the following three years.
The cliff serves a specific purpose: it prevents a co-founder from leaving after a few months and retaining any equity at all. If someone leaves before the cliff, the company can buy back 100% of their shares.
Milestone-based vesting is less common in co-founder arrangements but does appear in performance equity plans. It ties vesting to specific outcomes: a revenue target, a product launch, a funding round. Rather than time. These provisions require careful drafting because disputes about whether a milestone has been achieved are common.
Good leavers and bad leavers
When a co-founder or employee leaves, the terms on which the company buys back their unvested shares depend on how they left. This is governed by the good leaver and bad leaver provisions in the shareholders agreement.
A bad leaver is typically someone who resigns voluntarily, is dismissed for cause, or breaches their obligations to the company. A good leaver is typically someone who departs due to circumstances outside their control, such as death, permanent incapacity, redundancy, or termination by the company without cause.
The distinction matters because it determines the price paid on buy-back. Bad leavers typically receive nominal value (often the original issue price) for their unvested shares. Good leavers typically receive fair or market value. That is a significant difference in a company that has grown in value since the shares were issued.
These definitions need to be drafted carefully. A definition that is too broad in either direction creates problems. A bad leaver definition that catches unforeseen circumstances, or a good leaver definition that is too generous, can lead to disputes and outcomes neither party intended.
The Corporations Act requirements on buy-backs
Because vesting operates through a buy-back mechanism, the buy-back itself needs to comply with the Corporations Act. The first requirement applies regardless of the type of buy-back: the buy-back must not materially prejudice the company's ability to pay its creditors. You cannot use a buy-back to strip value from a company that cannot afford it.
Beyond that, the procedural requirements depend on how the buy-back is classified. The two most relevant categories for startup vesting arrangements are:
Employee share buy-backs. If the shares being bought back were issued under an employee share scheme, and the buy-back stays within 10% of voting shares in any 12-month period, no shareholder resolution is required, only 14 days' notice. Above that threshold, an ordinary resolution is required.
Selective buy-backs. Where shares are being bought back from a specific shareholder (as is often the case for co-founder departures), a selective buy-back applies. These are more procedurally demanding: a special resolution (or unanimous resolution) of shareholders is required, with the departing shareholder excluded from voting. Notice and lodgement requirements with ASIC also apply.
When shares are bought back, they are cancelled immediately. They do not sit in treasury. They cease to exist, and the remaining shareholders' percentage interests increase accordingly.
This means the shareholders agreement needs to be structured with the Corporations Act requirements in mind from the start. If the procedural requirements for a selective buy-back have not been factored into the drafting, the company may find itself unable to execute the buy-back smoothly when it matters.
Employee Share Option Plans (ESOPs)
For employees below co-founder level, Australian startups typically use an employee share option plan rather than issuing shares directly. Options give an employee the right to acquire shares in the future at a pre-set exercise price, usually equal to the market value of the shares at the time the options are granted.
Unlisted startups benefit from a reduced disclosure obligation when issuing options to employees. Offers under employee share schemes are exempt from the standard fundraising disclosure requirements under the Corporations Act, and they do not count toward the usual limits on offers to small numbers of investors. This makes ESOPs administratively straightforward for early-stage companies.
What happens to unvested options when an employee leaves
The default position is that unvested options lapse when an employee ceases employment, regardless of whether they resigned or were terminated. Plan rules typically give the board discretion to allow unvested options to be retained in defined circumstances such as redundancy, death or serious illness, but absent a decision to exercise that discretion, lapsing is automatic.
Employees need to understand the terms of their plan before resigning. The plan rules need to clearly set out what discretion exists and how it is exercised.
A note on implied obligations
One principle worth flagging for founders putting ESOP documentation together: courts have held that where a company can require an option holder to sign a shareholders agreement as a condition of exercising their options, that shareholders agreement must not be inconsistent with the terms of the option agreement. The company cannot use it to impose terms that effectively defeat the option holder's rights under the plan.
The practical implication is that your ESOP rules and your shareholders agreement need to be drafted and reviewed together. If they are inconsistent, or if the shareholders agreement purports to claw back rights the option plan has granted, you have a problem that is expensive to fix later.
The short version
Vesting ties equity to contribution and protects the company and the remaining founders if someone leaves early. In Australian practice, it operates through shares issued upfront with mandatory buy-back rights, not through progressive issuance. The buy-back mechanism needs to comply with the Corporations Act. Good leaver and bad leaver provisions determine what happens on departure. ESOPs are the standard tool for employee equity, and the plan rules need to work alongside the shareholders agreement, not against it.
Getting these arrangements right at the start is significantly cheaper than unwinding them after a co-founder dispute or an unexpected departure.
If you are setting up a shareholders agreement with vesting provisions, or establishing an ESOP for your team, speak to a lawyer at Plumlaw. We work with founders and startups at a fixed price. Get in touch at plumlaw.co/contact.
This post is general information only and does not constitute legal advice. If you have questions about a specific situation, you should speak to a lawyer at Plumlaw before acting.