I. Introduction

So-called “vesting provisions” are widespread for the founding shareholders of start-up companies after the entry of investors on the one hand and for management and employee participation programs on the other. The general idea behind vesting provisions is to create incentives for founders, managers or employees to commit to the success of the company over a predetermined period of time. Although they are very common in practice, there is still no decision of the Federal Court of Justice (Bundesgerichtshof – BGH) on the legal validity of vesting provisions. With the Berlin Court of Appeal (decision of 12 August 2024 – 2 U 94/21), a Higher Regional Court (Oberlandesgericht) has now for the first time ruled on a vesting provision for a start-up and deemed it valid. The decision therefore deserves attention and provides an opportunity to address the topic of founder vesting in the venture capital sector.

II. Areas of application of vesting provisions

As mentioned at the beginning, vesting provisions are often found in the shareholder agreement of a start-up fter the company – often a limited liability company (Gesellschaft mit beschränkter Haftung – GmbH) – has raised equity capital from investors. The start-up founders usually took over their shares at nominal value when the company was founded. The investors contribute equity capital in the financing rounds, which regularly increases the value of the founders’ shares considerably. The idea behind vesting is that the founders must first earn this increased value by contributing to the company’s success. However, it is not only in the investors’ interest to tie the founders’ know-how and commitment to the company for a certain period of time; it is also advantageous for the dynamics within the founding team if all members are equally committed.
A second important area of application for vesting provisions is any form of management and employee participation, for example, (a) through the issuance of so-called “hurdle shares” (i.e. real shares) in a start-up, (b) the creation of “virtual” shares under a participation program for managers and employees under the law of obligations or (c) the direct participation of managers as limited partners of a so-called “MIP-KG”, as is often the case with buy-and-build structures.
This article focuses on the vesting of founding shareholders of start-ups. Although vesting for managers or employees usually works in a similar way from a technical point of view, there are differences in the considerations behind it, which in turn are significant for the legal assessment.

III. Typical contents of a vesting provision

In very simplified terms, the vesting for the founding shareholders of a start-up, or their investment vehicles, works in such a way that a founder can only receive the full market value of his or her interest subject to vesting as compensation or as part of the distribution of proceeds after an exit if he or she has actively worked for the company for a certain period of time. After expiration of the so-called “vesting period”, which in practice is 2 to 5 years – often depending on whether the company is still in an early stage or has already grown – all of the founder’s shares are considered “vested”. Sometimes only a certain percentage of the founder’s shares are considered “vesting shares”; this is particularly the case if the founder has already worked for the company for many years. During the vesting period, the shares vest at regular intervals; for example, if the vesting period is four years, 1/48 of the vesting shares could vest each month. Occasionally, vesting is paused as long as a founder is not actively working for the company, e.g. due to a sabbatical or parental leave (not, however, maternity leave).
If the founder’s work for the company ends during the vesting period, the founder at least “loses” his unvested vesting shares in return for a compensation. Technically, this is usually done via a call option, or alternatively via a redemption (Einziehung). The compensation for the unvested vesting shares regularly corresponds to the lower of (a) the acquisition costs for the vesting shares, i.e. usually the nominal amount in case of a limited liability company, or (b) the market value of the vesting shares.
In the case of vested shares, however, the termination of the shareholder status and the amount of the settlement generally depend on whether the founder leaves the company as a so-called “good leaver” or whether a “bad leaver” situation exists. A range of typical provisions have also developed in practice for this. Put simply, good leaver cases are those in which the founder’s work for the company ends through no fault of his own, while bad leaver cases are those in which the founder is responsible for his own departure. In the case of a good leaver, the founder receives the full market value (at that point in time) for the vested shares, or the founder is allowed to keep his vested shares and thus has the chance to participate in an exit in the future. In the case of a bad leaver, on the other hand, the compensation for the vested shares generally corresponds only to the acquisition costs or, should this be lower, the market value.
Other common practices are the so-called “cliff period” and “accelerated vesting”. The cliff period, which is particularly common in early-stage investments, is a rule whereby the vesting shares do not vest gradually, e.g. monthly, during an initial phase of the vesting period, but only after the initial period has expired, which is often one year. In the above example of a vesting period of four years, one-quarter of the vesting shares would be considered vested after the one-year cliff period has expired; however, no vesting shares would be vested before the end of the cliff period. Accelerated vesting, on the other hand, means that if an exit occurs during the vesting period, all vesting shares are considered to be vested.

IV. Legal requirements for a vesting agreement

When implementing vesting agreements, it is important to comply with the legal requirements. However, these are not defined in detail and there is still a lack of specific Federal Court of Justice rulings on vesting in the start-up sector.
One core aspect that must be observed is the prohibition of dismissal clauses (Hinauskündigungsklauseln), as such could be null and void due to their immorality in accordance with § 138 para. 1 German Civil Code (Bürgerliches Gesetzbuch – BGB). A shareholder should not be influenced in the exercise of his shareholder rights by the “sword of Damocles” of the termination of his shareholder position at any time. According to established case law, agreements that give the other shareholders the right to exclude a co-shareholder from the company without good cause are therefore invalid, unless such a provision is objectively justified due to special circumstances. The question of whether the considerations behind a vesting provision for the founders of a start-up can constitute such an objective reason has not yet been clarified by the courts. In legal literature, the common vesting provisions in practice, as described above, have been recognized as lawful because the other shareholders are not allowed to simply terminate the contract of a shareholder. Rather, the termination of the shareholder position is only possible for objective, predefined reasons. Furthermore, the reasons mentioned above for introducing a vesting provision constitute a sufficient objective reason for the partial or complete termination of the shareholder status. The past decisions of the Federal Court of Justice on other case groups, in particular on management participations, employee participations and exclusion options after the expiry of a probationary period for freelancers (Freiberufler), served as a guideline for this assessment.
A second important aspect of the contract design is the agreement of an appropriate compensation for the shares that the shareholder loses. If the agreed settlement is already too low when the contract is concluded, the entire compensation may be void, which is why the inclusion of catch-all clauses is recommended. If it only later turns out to be inappropriately low due to a change in the value situation, the legal consequence is usually a judicial adjustment to an appropriate amount as part of a supplementary interpretation of the contract, which can also be directly reflected in the contract by means of corresponding catch-all clauses.

V. Decision of the Court of Appeal

The Court of Appeal commented on the first of the two legal questions mentioned above in its indicative resolution (Hinweisbeschluss). This was apparently based on a case in which three people had originally founded a limited liability company that developed software with significant input from the founders between 2012 and 2017. In 2018, investors finally invested a total of EUR 1.373 million in return for new shares in the company. The founders, who were to have an indirect interest in the company through a joint holding company, were to continue working for the start-up. Vesting provisions were ultimately provided for at the company level for the investment vehicle and, accordingly, at the holding company level for the founders. The plaintiff founder became a good leaver within the first year of the three-year vesting period when his employment contract with the company was terminated with notice. Apparently, the vesting provision provided for a kind of cliff period, because the founder was to leave the holding company completely in return for a compensation payment equal to the nominal value of his shares.
The court found no legal objections to this provision under the standard of § 138 para. 1 BGB and the case law on dismissal clauses. In the opinion of the Court of Appeal, there was a need for a time-limited vesting period because the founders could not offer the venture capitalists any guarantees, including that they would contribute to the future success of the company. Furthermore, it was justified that the founders had yet to earn the increase in value of their shares as a result of the investors’ entry. If vesting provisions were inadmissible, the investors would price this into their investment decision. However, the vesting provisions not only served to financially secure the investment, but also as a kind of probationary period, in particular the cliff period that was apparently agreed. The founders’ point of view also justifies the vesting, because it gives them the opportunity to resolve disagreements within the founding team relatively easily. Furthermore, the amount of the compensation payment is irrelevant for the effectiveness of the possibility of termination. Even if the compensation is unreasonably low, it will be replaced by reasonable compensation. However, the appropriateness of the compensation at nominal value was not the subject of the indicative decision.
The court also could not recognize any unjustified unequal treatment of the plaintiff shareholder, because, on the one hand, his co-founders were subject to the same vesting rules. On the other hand, there was an objective reason for the different treatment of the investors: the investors were to contribute to the success of the company through capital, while the founder was to contribute through his personal work.
Furthermore, the court examined whether the exercise of the call option in the specific case at hand would stand up to the requirements of good faith. In addition to the effectiveness of the clauses for the shareholder’s withdrawal, the exercise of a call option must not be contrary to good faith. The shareholders would be denied the assertion of the call option if they had brought about the occurrence of the conditions for exclusion in bad faith, which was denied in the case under review.
The court finally addressed the question that regularly arises in practice as to when the call option must be exercised – depending on the beginning of a garden leave or on the legal termination of the employment relationship. The specific agreement is decisive in this regard. The Court of Appeal ruled that the contractual wording “is terminated” means that the only circumstance that matters is when the termination takes effect, and not an earlier “de facto termination” of the employment relationship by way of a garden leave. If the earlier point in time of a leave of absence is to be decisive, this would have to be agreed accordingly. The Court of Appeal also made it clear that the informal “promise” of a termination cannot be the deciding factor either.

VI. Outlook and consequences for the practice

It is positive for practitioners that a Higher Regional Court has finally dealt with the implementation of vesting provisions and has recognized the reasoning for them as objectively justified. It is noteworthy that the founder had already worked on the software relevant for the company and directly in the company’s business operations for seven years before his termination, and yet was to lose all of his shares under the vesting provision. This was possible because the company was able to terminate the founder’s employment relationship with notice, i.e. without good cause, which apparently was not aggravated by a fixed term or similar. Thus, a rather critical vesting provision was approved by the court.
To achieve further legal certainty, a decision by the Federal Court of Justice (Bundesgerichtshof – BGH) on vesting for founding shareholders would still be desirable. Questions also remain unanswered regarding the amount of compensation for vesting, and the general requirements of case law must still be taken into account. The appropriateness of the contractual vesting provisions should therefore continue to be examined individually by a lawyer during negotiations.