Vesting

I. Introduction & Core Definition:

Vesting refers to the process by which an individual earns the right to receive employer-provided assets or benefits—most commonly company equity (such as stock options or shares)—over a scheduled period of employment or continued association with a startup or business. In startups, co-founders, employees, and advisors are often granted stock options, restricted stock, or other forms of equity that only become fully owned or exercisable according to a predetermined vesting schedule. Vesting is a fundamental tool for incentivizing long-term commitment, aligning interests, and reducing turnover risk among team members.

II. Deeper Dive into the Concept:

A typical vesting arrangement involves:

• Vesting Schedule: The timeline over which shares or options become vested, commonly spanning 3 to 5 years.
• Cliff: An initial period (often 1 year) during which no equity vests. If the person leaves before the cliff, they receive nothing. After the cliff, a lump sum vests, followed by monthly or quarterly vesting thereafter.
• Accelerated Vesting: Under certain conditions (such as a company acquisition or termination without cause), vesting can speed up, either partially or fully.

For example, a standard 4-year vesting schedule with a 1-year cliff means that after one year of service, 25% of the equity vests at once, then the remaining 75% vests monthly over the next three years.

III. Significance & Implications for Founders:

Vesting is crucial for founders and employers to:

• Prevent immediate full ownership by co-founders or employees who may leave prematurely, thereby retaining the equity pool for future use and preventing resentment from lingering co-founders or investors.
• Incentivize long-term commitment and sustained performance.
• Provide protection against co-founder disputes by ensuring that only those who materially contribute to the company over time benefit proportionally.
• Satisfy investor requirements; most venture capitalists insist founders adopt industry-standard vesting policies before investing.

For employees, vesting represents a path to meaningful ownership in the company and a potential financial upside if the company succeeds or exits.

IV. Practical Application & Examples:

Suppose a startup grants its CTO 20,000 stock options subject to a 4-year vesting schedule with a 1-year cliff. No options vest in the first 12 months. On the first work anniversary, 5,000 options (25%) vest. Thereafter, 1,250 options vest every quarter. Should the CTO resign 18 months in, she would have vested 7,500 options and forfeit the remaining 12,500 options back to the company’s option pool.

In acquisition scenarios, a typical provision is the “single trigger” or “double trigger” acceleration. For instance, a double trigger means full vesting if the company is acquired and the employee is involuntarily terminated soon after.

V. Key Considerations & Best Practices:

1. Standardization: Employ a clear, standard vesting policy across the company to prevent internal disputes.

2. Clear Documentation: Vesting terms should be clearly described in offer letters and founder agreements to preempt misunderstandings.

3. Use Appropriate Schedules: Four years with a one-year cliff is a market standard, but variations may exist based on role and negotiations.

4. Consider Accelerated Vesting with Caution: While appealing during acquisitions, excessive acceleration provisions may deter buyers.

5. Regular Reviews: Update and communicate vesting schedules during funding rounds or organizational changes.

VI. Related Terms & Further Reading:

• Stock Options
• Restricted Stock Units (RSUs)
• Employee Stock Option Plan (ESOP)
• Founder Agreements
• Cliff (Vesting)

VII. Conclusion:

Vesting is a cornerstone of modern startup compensation and founder equity arrangements. It serves as both a retention mechanism and a fairness tool, ensuring that ownership accrues to those who actively build and grow the business. Founders and early employees should familiarize themselves with vesting terms to make informed decisions, both when setting up a new venture and when accepting offers from existing startups.