In the unfortunate case when your co-founder (or employee) leaves, she might try to sell her vested shares in the secondary market. This might not be good because what if these are being sold to the competitor, or you’re trying to raise funds and these are being sold at cheaper valuations.

This is where the clause of Transfer Restrictions is helpful. It prevents secondary transfers of shares.

Now the next question is would investors be okay with it? Probably not. So one good way to start is to include it in the Founders Agreement and ESOPs plan (also called Founder Restricted Stock Purchase Agreements) so that all of the common stock held by founders and employees is covered by such restrictions.

Another important addition is to permit the board to waive the transfer restrictions. This might be exercised when the board is okay to allow the sale along with a fundraising round. Now if you have this added, then you might want to apply the restrictions to both common stock(held by founders+employees) and preferred stock(held by investors). Why? Because now it is easy to waive as and when required. Also if you have raised a round from angel investors, then future VCs might prefer angels to be bound by the same restrictions. Also, it is easy to include the clauses at the beginning as compared to imposing later, and easy to remove later if required.

There is another common clause which we will discuss in the next post - If someone wants to sell her stake to a third party, you can have the right to purchase the equity by matching the offer. However, if these are being sold at too high valuations, you might not be able to use this right. So adding transfer restrictions is a more effective way to prohibit any secondary sale that is not authorized by the company.

Usual disclaimer: Discuss with a lawyer for professional advice