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Options and restricted stock in a startup are subject to vesting. This is done to associate the rewards of equity ownership with the time and effort put into creating value for the company.
Although vesting schedules can be infinitely flexible in theory, in practice they don’t vary that much. You’ll find that the majority of option plans and restricted stock agreements are identical in meaning and vary slightly with how vesting is structured. Most vesting schedules have the following parameters:
- Vesting period. This is the expected period for full vesting. It is typically 4 years (48mos) in the case of employees and 3 or 4 years in the case of founders. Some have argued that vesting periods should be extended to 5 years because it often takes longer to build a significant company these days but they are a minority. Advisors and other non-standard roles can have 12 or 24 month vesting periods. Sometimes the negotiations over the vesting period of founders can get pretty contentious. When I started in venture I used to see more 3 year vesting schedules and then the market moved to 4 years while preserving founders’ acceleration as described below. Another variation you’ll sometimes see is quarterly as opposed to monthly vesting. I think this is a terrible idea. Like the cliff, which is described below, any discontinuities in the vesting schedule create an environment for incentives misalignment.
- Starting acceleration. This is done to reward people involved in the founding of a company. Founders typically get 25% vesting acceleration but sometimes this can be more, e.g., if the founders bootstrapped the company for a significant period of time.
- Cliff. The cliff is the hurdle one needs to cross before vesting begins. You are unlikely to see cliffs in a plan with starting acceleration–founders don’t have cliffs in the their vesting schedules. It is common for employees to have a 12month cliff. If the vesting period is 48 months and the cliff is a year this means that no vesting will happen for the first year and then 25% (12/48) of the grant will vest on the first anniversary of the grant. This is meant to protect a company in the case of a bad hire but many argue that it unfairly penalizes employees. What happens in the case of someone leaving or being terminated before the cliff is reached is up to the CEO and the board. The board of directors typically has to approve any changes to option grants and restricted stock agreements. From a legal standpoint, the person doesn’t have a right to any equity. From a practical standpoint, however, for valuable contributors leaving on friendly terms some type of middle ground agreement is reached. An often unintended consequence of cliffs is unhappy employees leaving on their first anniversary. They probably checked out months before but they wanted to wait to get their their 25%.
- Ending acceleration. This is meant to handle accelerating vesting in the case of a termination or change of control (M&A, etc.). Vesting schedules for most employees typically have no acceleration provisions. Some execs with a lot of leverage during the recruiting process can negotiate termination acceleration. 25% is common if they’ve worked for more than a year and 50% if they’ve worked for more than two years. It is also common for some founders and execs to have what is known as double trigger acceleration on change of control. This means that (1) the company will need to be acquired and (2) the person will need to be fired, hence the “double” trigger. (Lawyers further restrict the firing to be without cause, meaning if you do something inappropriate or just plain stop showing to work you don’t get accelerated.) The typical acceleration amount is 25% or 50%. Sometimes this is measured on the total grant and sometimes it is measured on the amount of unvested shares. The former is more common in my experience. Single trigger (just the company being acquired) is unusual, except in the case of board members and some type of advisors who wouldn’t be expected to serve the company following an acquisition.
With the definitions out of the way, here is a vesting calculator you can use to see how far you’ve gotten along with your vesting.
The default values above show a founder-style vesting schedule. The total grant is for 100,000 shares. It was made on March 12, 2007. 25% acceleration credit (25,000 shares) vested on March 12, 2007. There is no cliff and thus, from that point on, 1,563 shares will vest monthly for the next 4 years (75,000 shares divided by 48 months rounds up to 1,563 shares/mo). There is no acceleration in the case of change of control here. On December 1, 2009 3/4 of the grant (75,000 shares) will have vested in total.
Let’s take a look at a more typical employee vesting scenario. With no starting acceleration and a cliff, an employee will have vested only 2/3 of the way. The cliff makes no difference here because the person has been with the company for more than a year.
Lastly, let’s look at a typical board member vesting schedule. No starting acceleration and no cliff with 100% ending acceleration (full vesting in the case the company is acquired).
Certain special roles require different types of vesting schedules in order to align work with the value it creates. For example, I’ve had two year vesting schedules in the companies I’ve co-founded with accelerators tied to the key milestones I’ve helped the company achieve. In one case, I recruited an executive chairman whose vesting schedule was nearly entirely milestone-driven.
In my companies I like to use the following as a guide for traditional roles:
- Founders: 4 year vesting with 25% up front, no cliff (and 50% double trigger acceleration for certain type of executive founders)
- Employees: 4 year vesting with a 12 month cliff
- Executives: 4 year vesting with a 12 month cliff and 50% double trigger acceleration
- Board members: 4 year vesting with 25% up front if they join before the first financing and 100% single trigger acceleration
- Advisors: 2 or 4 year vesting with 100% single trigger acceleration