What is Vesting?
Vesting is a mechanism that allows employees to earn equity over time, transforming stock options from a simple promise into a powerful motivational tool. It serves two primary purposes:
- Reward employees for their long-term commitment
- Protect the company by ensuring key talent remains engaged
Types of Vesting Schedules
Startups have several approaches to structuring equity compensation:
Time-Based Vesting
The most common approach, where employees earn shares gradually over a set period. Typically, this follows a four-year schedule with a one-year cliff.
Performance-Based Vesting
Ties equity earnings to specific company or individual performance milestones, such as:
- Revenue targets
- Product development goals
- Strategic objectives
Hybrid Vesting
Combines time-based and performance-based approaches to create nuanced, personalized equity strategies.
The Importance of the "Cliff"
A vesting cliff is a critical component of most equity plans:
- Typically set at one year
- Ensures employees are a good fit before receiving any equity
- Protects the company from premature equity distribution
A Typical Vesting Scenario
Consider a standard four-year vesting schedule with a one-year cliff:
- First year: 0% vested
- After one year: 25% of shares vest
- Remaining shares vest monthly over the next three years
Common Pitfalls to Avoid
Startups should be mindful of potential vesting schedule mistakes:
- Failing to communicate clearly about equity terms
- Using a one-size-fits-all approach
- Neglecting to revisit vesting schedules as the company evolves
The Broader Impact
Vesting schedules do more than distribute equity:
- Create a culture of ownership
- Align employee and company interests
- Provide a powerful retention tool
- Motivate long-term commitment
Conclusion
Vesting schedules are more than just a legal mechanism—they're a strategic tool for building a committed, motivated team. By carefully designing these schedules, startups can create a collaborative environment that drives long-term success.
Our firm specializes in helping startups develop comprehensive equity compensation strategies that attract and retain top talent. We can provide personalized guidance to ensure your vesting approach supports your company's unique goals and vision.
Frequently Asked Questions
FAQs
What is the most common vesting schedule for startups?
The standard structure is a four-year schedule with a one-year cliff, followed by monthly or quarterly vesting for the remaining equity.
Why do companies use a vesting cliff?
A cliff ensures employees demonstrate commitment and cultural fit before receiving ownership. It also protects the company from granting equity to short-term hires.
Can vesting schedules be customized?
Yes. While time-based vesting is standard, many startups use performance-based or hybrid structures to align equity with specific goals or milestones.
Do vesting schedules apply only to employees?
No. Vesting schedules can also apply to contractors, advisors, and executives who receive equity compensation under the company’s equity incentive plan.
Don't DIY your legal anymore
Leave it to the pros.