Starting a business in Pennsylvania is exciting, but the honeymoon phase does not last forever. Here is how to protect your new company and yourself when reality sets in. You and your co-founder have the perfect idea. You have sketched it out on a napkin in a Philadelphia coffee shop, or perhaps you have already started coding in a Pittsburgh basement. The energy is high, the trust is implicit, and you agree to split everything 50/50. You shake hands and get to work.

In the early days of a Pennsylvania startup, discussing legal protections feels like planning for a divorce before the wedding. It seems pessimistic to suggest that one of you might lose interest, take another job, or underperform.

But as small-business attorneys serving the Commonwealth, we see it happen frequently. Life happens. Circumstances change. And when a founder leaves prematurely, holding half of your company’s equity and having put in only a fraction of the work, it can cripple your business before it even gets off the ground.

There is a simple, standard legal mechanism designed to prevent this exact scenario, ensure fairness, and demonstrate a serious commitment to future investors. That mechanism is the equity vesting schedule. Choosing the right vesting structure often goes hand in hand with entity formation and governance decisions, which is why many founders work with our experienced startup and business law attorneys to ensure their agreements align with long-term growth and investor expectations.

What is Equity Vesting

In short, equity vesting means that while founders are granted their shares in a corporation or membership units in an LLC on day one, they do not truly own them until they have earned them over time.

Think of it not as buying stock, but as earning the right to keep it through continued service to the company. If a founder leaves the company before their shares fully vest, the company has the right to repurchase the unvested shares, usually at a nominal price; alternatively, the shares may be forfeited to the company treasury. Vesting converts paper ownership into real ownership through sweat equity.

Why Vesting is Necessary and the Free Rider Problem

Imagine you and a partner start a tech services firm in Harrisburg. You split the equity 50/50. Six months in, the work is grueling and unpaid. Your partner decides this is not for them and takes a salaried corporate job elsewhere.

Without a vesting agreement, that former partner still owns 50 percent of your company. Five years later, when you have grown the business to five million dollars in revenue through sheer grit, that absent partner still owns half of it.

This is the free rider problem. It is profoundly unfair to the remaining founders and a major red flag for investors. No venture capitalist or sophisticated angel investor will invest in a company where a significant portion of the cap table consists of dead equity held by someone no longer contributing.

A vesting schedule solves this by ensuring alignment. It dictates that everyone is on the same timeline and shares the same long-term commitment.

The Mechanics of the Vesting Schedule

While vesting schedules can be customized to fit any business, there is a very strong industry standard, particularly for high-growth startups.

Four-Year Vesting with a One-Year Cliff

This is the gold standard. Here is how it works. You are granted 100 percent of your promised equity on the day you sign your Restricted Stock Purchase Agreement or equivalent LLC operating agreement provision.

The Cliff in Year One

For the first twelve months, zero equity vests. If a founder leaves on day 364, they receive nothing. This acts as a probationary period to ensure the founder is truly a good fit.

The Cliff Vesting Date

On the one-year anniversary, 25 percent of the founder’s total equity vests instantly.

Monthly Vesting in Years Two Through Four

The remaining 75 percent of the equity vests in equal monthly installments over the next thirty-six months. At the end of four years, the founder fully owns 100 percent of their stake.

What Happens if the Company Is Acquired

Vesting agreements also need to address positive outcomes. If your company is acquired two years into a four-year vesting schedule, the agreement must define what happens to the unvested shares.

Typically, agreements include acceleration clauses. A single-trigger acceleration means all unvested shares vest immediately upon the company’s sale. A double trigger acceleration, which is more common and investor-friendly, requires two events. First, the company is sold. Second, the founder is terminated without cause by the new owners or leaves for good reason within a defined timeframe.

Business acquirers often want founders to remain with the company after the acquisition to ensure a smooth transition. The double trigger structure balances founder protection with buyer expectations.

Pennsylvania Entity Structures and the Critical Tax Trap

Whether you are structured as a Pennsylvania corporation or a Pennsylvania limited liability company, vesting can and should be implemented.

For corporations, vesting is handled through a Restricted Stock Purchase Agreement. For LLCs, vesting provisions are set forth directly in the company’s operating agreement and apply to membership units. However, there is one major federal tax issue that every Pennsylvania founder must understand.

The 83(b) Election

When you receive equity that is subject to vesting, the IRS treats it as taxable income. If you do not act, you will be taxed on the shares’ value when they vest. If your company grows rapidly, you could owe substantial income taxes each year on equity gains that you have not realized in cash. This also requires the company to determine its fair market value at each vesting period, which is impractical for most startups.

The solution is the 83(b) election. This election allows you to be taxed on the entire value of your shares on the day they are granted, when the company is typically worth very little. You pay a small amount of tax upfront and then recognize capital gains only when the equity is eventually sold.

The Thirty-Day Deadline

There is a strict thirty-day window from the date you receive your equity to file the 83(b) election with the IRS. If you miss this deadline by even one day, there is no remedy. This makes early coordination with your attorney and accountant essential.

Key Take-Away: Get it in Writing

A vesting agreement is not about a lack of trust. It is about professionalizing your business relationship. It ensures that ownership rewards the founders who actually put in the work to create value.

If you are launching a venture in Pennsylvania, do not rely on a handshake. Protect your future and promote long-term fairness by implementing a thoughtful and well-drafted vesting schedule.

If you are forming a startup or revisiting your founder equity structure, experienced legal guidance can help you avoid costly mistakes. Schedule a consultation online with Nathan Wenk at Spengler & Agans to receive guidance tailored to your business goals and entity structure.