Co-founder equity: vesting, 83(b), and what happens when a founder leaves

Two or three people start a company. They split ownership evenly, because that feels fair and nobody wants the awkward conversation. Eighteen months later one of them takes a job somewhere else and keeps their third. The founders still doing the work now carry a passive owner for the life of the company, and investors notice.

Three tools prevent that: vesting, the 83(b) election, and a written plan for a founder's exit.

Vesting. Each founder gets their full ownership on day one, but the company has the right to buy back the unvested portion if the founder leaves. A common pattern runs four years with a one-year cliff: nothing vests in the first year, a quarter vests at the one-year mark, and the rest vests monthly after that. Nothing about those numbers is required. What matters is that the founders choose them on purpose and write them down. In a corporation this is usually a restricted stock purchase agreement. In an LLC it lives in the membership interest grant and the operating agreement's repurchase terms.

Vesting protects every founder, including the one who leaves. It replaces a fight with a formula.

The 83(b) election. When founders receive stock that is subject to vesting, the default tax rule taxes each piece as it vests, at its value on that date. If the company grows, each later slice is taxed as ordinary income at a higher value, even though no cash changed hands.

An 83(b) election flips that. The founder elects to be taxed on the full grant at the moment it's received, when it's usually worth very little. Future growth then becomes capital gain, taxed only when the shares are sold.

The deadline is strict: 30 days from the date the stock is transferred. There is no late election and no extension. The IRS now offers Form 15620 for the election, and it can be filed online through the IRS website or mailed. Give a copy to the company and keep one yourself. Missing this window is one of the most expensive mistakes a founder can make, and it can't be fixed later.

LLC founders receiving a profits interest often file a protective 83(b) as well. Ask your tax adviser before the 30 days run.

When a founder leaves. Decide this before anyone wants to. The agreement should say what happens to vested and unvested equity, and at what price, depending on why the founder left: quit, fired for cause, fired without cause, disability, or death. It should say whether the company or the remaining founders buy the shares, how the price is set, and whether payment comes over time. Buying out a member: what actually has to happen covers the mechanics.

The pieces that get forgotten. Every founder should assign to the company any intellectual property they created for it, including work done before formation. Without that assignment, a departing founder may walk out still owning the code, the brand, or the client list. And if a founder is contributing work rather than money, write down what they're contributing and what they receive for it. One partner does all the work covers unequal effort. Taking equity for your work while you're in bankruptcy or behind on debts covers the founder with creditors.

Before outside money arrives. Investors will ask whether founder equity vests, whether 83(b) elections were filed, and whether IP was assigned. A clean answer to all three makes a raise faster. A messy one can stall it. Do you have to convert your LLC to take on investors? covers the entity side.

Have the conversation while everyone still agrees. It only gets harder.

Book a consultation if you're setting up founder equity.

This is general information, not legal advice for your situation. If you want an answer for your situation, book a consultation.