One of the key drivers of startup success is the concept of stock option grants to employees, founders, advisors, directors, and consultants. This is how startups attract spectacular talent whilst still being young and cash-strapped. However, handing out equity to anyone and everyone poses a risk: they can depart from the startup, and leave it without talent and with less control over its equity. The solution? Vesting schedules.
First Off: What is Vesting?
Typically, in law, rights vest as soon as they are transferred. For example: if I sell you a new computer, you receive ownership right of that computer, and typically your ownership rights are also fully vested as soon as the contract has been concluded. This means, essentially, that your right to the computer is secured and cannot be taken away by a third party, even if you are not yet in possession of the computer.
Without vesting schedules, the same would be true of stock or option grants: as soon as an employee is granted stock or option ownership, those ownership rights are vested and therefore secured. A vesting schedule separates the actual contract to transfer ownership from the vesting of that ownership right. In other words, the right to ownership vests gradually, over time, while you work for the startup. A great incentive to stay on.
Vesting periods are determined in stock purchase agreements. These are usually carefully scrutinized by investors during due diligence, and it is therefore important for a startup to have a standardized and formalized approach to all vesting terms associated with your startup’s equity grants.
1. Typical Vesting Schedules for Founders
Founders are the heart and soul of their startups, and might be rewarded for that with less strenuous vesting schedules than other parties. Sometimes, founders agree that a portion of their stock grants will vest “up front”, i.e. that they receive a certain percentage of stock immediately while the rest vests over time.
Up front vesting is usually granted to founders who contributed significantly to the startup’s inception – in the form of intellectual property, for example. Generally, founder stock is not subject to cliff vesting (i.e. they start vesting immediately). However, if co-founders do not know each other very well, they might want to agree to cliff vesting to lower the risk of one founder upping and leaving unexpectedly.
Apart from these two variations, founder stock tends to vest similarly to that of employees:
2. Typical Vesting Schedules for Employees
As a general rule, all employees usually agree to the same vesting period, regardless of their seniority. Standard practice is to have employee stock vest proportionally over a period of four years, on a monthly basis, with a one year cliff. This means that 25% of stock vests each year for the first four years of that employees’ employment at the startup, in monthly (or sometimes quarterly) increments. The first year’s 25% of stock or option grants only vests after the whole year has elapsed (i.e. after 12 months).
Typical Vesting Schedules for Consultants, Advisors, and/or Directors
Directors are usually engaged on similar vesting schedules as employees, although their expertise might allow them to negotiate for shorter vesting periods or the exclusion of cliff vesting.
Advisors and consultants face varying vesting periods dependent on their role with the startup. If they are engaged for a fixed period of time, vesting might run over that period of time (for example, one year). Alternatively, if the time period of their work for the startup is uncertain, vesting might be made dependent on the achievement of specific milestones and outcomes.