Here’s Everything You Need To Know About Vesting

What Is Vesting?

Vesting is a process in which employees or founders earn ownership rights to something, such as stock options or retirement benefits, over a period of time. In the context of startups and companies, vesting is commonly associated with stock options or equity grants. It ensures that individuals gain ownership of their allotted shares gradually, usually over a specified period, rather than receiving them all at once.

Why Do Founders Need Vesting?

Founders of startups often face the need for vesting to safeguard the long-term commitment and alignment of the team. Vesting helps mitigate the risk of a founder leaving the company prematurely, as it ensures that their ownership stake is earned gradually over time. This is crucial for maintaining stability, as startups rely heavily on the dedication and continuous efforts of their founding team.

What Is ‘Exercising The Right To Shares’?

Vesting involves a specific timeline during which individuals must remain with the company to fully “earn” their shares. Once this period is completed, they can exercise their right to the shares. It involves purchasing the shares at a predetermined price, often referred to as the “strike price” or “exercise price”, which is set when the equity is granted.

What Are Common Vesting Schedules?

Vesting schedules can vary, but two common structures are the “cliff” and “graded” vesting. Under the cliff vesting schedule, individuals do not gain ownership rights to any shares until a certain period (the cliff) has passed. In graded vesting, a portion of the shares vest gradually over time, typically on a monthly or quarterly basis, until the full allocation is earned.

Which Vesting Terms Should You Know?

• Cliff Period: The initial period in a vesting schedule during which no shares are earned.
• Vesting Period: The total duration over which shares are earned. It’s often expressed in years.
• Acceleration Clause: A provision that allows for acceleration of vesting in certain events such as an acquisition or a merger.
• Forfeiture: If an individual leaves the company before the vesting period is complete, they might forfeit the unvested portion of their shares.

What Is Accelerated Vesting?

Accelerated vesting can be triggered by specific events, like a change of control (acquisition or merger), death, disability, or other predefined circumstances. This provision ensures that employees or founders don’t lose out on their ownership stakes if the company’s situation changes unexpectedly. It’s a protective measure to maintain fairness and reward for contributions.

Why Is Vesting Important?

Vesting benefits both individuals and the company. For founders and employees, it encourages commitment and long-term dedication, as the value of their equity is tied to their tenure. It promotes teamwork and minimises the risk of a key team member leaving prematurely. For companies, vesting provides stability, as ownership is earned over time, preventing sudden changes in ownership structure that can be disruptive. It also aligns the interests of founders and employees with the company’s growth and success, fostering a shared sense of purpose.