Understanding Share Vesting: Protecting Your Startup Equity
Share vesting is a mechanism that earns equity over time, protecting companies and investors from cofounders or employees who leave early. Vesting shares ensures that equity compensation is tied to continued contribution, aligning incentives between founders, employees, and investors.
Whether you’re a startup founder negotiating with investors or an employee evaluating a stock option package, understanding vesting schedules is essential for making informed decisions about equity compensation.
How Share Vesting Works
When shares vest, they transfer from a conditional grant to full ownership. Until shares vest, they remain subject to forfeiture if the holder leaves the company. The vesting schedule determines when and how shares become fully owned.
Key Vesting Components
- Vesting period: Total time required for full vesting (typically 4 years)
- Cliff: Initial period before any shares vest (typically 1 year)
- Vesting schedule: How shares vest after the cliff (monthly or quarterly)
- Acceleration: Events that speed up vesting (acquisition, termination)
Standard Vesting Schedules
The most common vesting schedule in startups is “4-year vesting with a 1-year cliff.” Here’s how it works:
The 4-Year Vesting Schedule
- Year 1 (Cliff): No shares vest. If you leave before 12 months, you receive nothing.
- Month 12: 25% of shares vest immediately (the cliff)
- Months 13-48: Remaining 75% vest monthly (1/48th per month)
- Month 48: 100% vested – full ownership achieved
Example: An employee granted 48,000 shares on 4-year vesting:
– After 1 year: 12,000 shares vested (25%)
– Each month thereafter: 1,000 additional shares
– After 4 years: 48,000 shares fully vested
Founder Vesting Considerations
Most investors require founder shares to vest, even for founders who have worked on the company for years. This protects all shareholders if a cofounder leaves early.
Founder Vesting Best Practices
- Credit for time served: Founders may negotiate credit for months already worked
- Acceleration on acquisition: Single or double-trigger acceleration clauses
- Good leaver provisions: Different treatment for voluntary vs. involuntary departure
- Board discretion: Flexibility for exceptional circumstances
Stock Vesting for Employees
Employee stock options typically follow similar vesting schedules to founder shares. Key considerations include:
Stock Option Vesting
- Option vesting: Right to purchase shares vests over time
- Exercise price: Price to purchase shares (usually fair market value at grant)
- Exercise window: Time to exercise after leaving (90 days typical)
- Early exercise: Some companies allow exercising unvested options
Vesting Agreement Essentials
A stock vesting agreement should clearly specify:
- Total number of shares subject to vesting
- Vesting commencement date
- Cliff period and vesting schedule
- Acceleration triggers and terms
- Repurchase rights for unvested shares
- Tax treatment and 83(b) election considerations
Acceleration Clauses
Vesting acceleration speeds up the vesting schedule under certain conditions:
Single-Trigger Acceleration
Vesting accelerates upon a single event (usually company acquisition). All or a portion of unvested shares vest immediately when the company is acquired.
Double-Trigger Acceleration
Requires two events: company acquisition AND termination of employment (usually within 12-24 months). This is more common as it doesn’t automatically pay out on acquisition.
Frequently Asked Questions
What is share vesting?
Share vesting is a mechanism where equity ownership is earned over time. Shares subject to vesting become fully owned according to a schedule (typically 4 years with a 1-year cliff). Until shares vest, they may be forfeited if the holder leaves the company.
What is a typical vesting period?
The standard vesting period for startup equity is 4 years with a 1-year cliff. This means no shares vest in the first year, 25% vest at month 12, and the remaining 75% vest monthly over years 2-4. Some companies use 3-year vesting for specific situations.
What is a vesting cliff?
A vesting cliff is an initial period (typically 1 year) during which no shares vest. If someone leaves before the cliff, they forfeit all equity. At the cliff date, a significant portion (usually 25%) vests immediately. The cliff protects companies from people who join briefly and leave with equity.
Do founder shares need to vest?
Yes, most investors require founder shares to vest, even for founders who started the company years earlier. Founder vesting protects all shareholders if a cofounder leaves. Founders may negotiate credit for time already served or accelerated vesting terms.
What is a vesting schedule?
A vesting schedule defines when and how shares become fully owned. The most common schedule is monthly vesting over 4 years with a 1-year cliff. Alternative schedules include quarterly vesting, performance-based vesting, or milestone-based vesting.
What happens to unvested shares when I leave?
Unvested shares are typically forfeited when you leave a company. The company usually has a right to repurchase unvested shares at the original grant price or a nominal amount. Vested shares remain yours (subject to any company repurchase rights at fair market value).
What is vesting acceleration?
Vesting acceleration speeds up the vesting schedule under certain conditions. Single-trigger acceleration occurs upon one event (like acquisition). Double-trigger requires two events (acquisition plus termination). Acceleration clauses are negotiated as part of equity grants.
Should I file an 83(b) election?
An 83(b) election allows you to pay taxes on unvested shares at grant (when value is typically low) rather than at vesting (when value may be higher). This can save significant taxes if share value increases. You must file within 30 days of grant. Consult a tax advisor for your specific situation.
What’s the difference between vesting shares and stock options?
Vesting shares (restricted stock) are actual shares that vest over time. Stock options are the right to purchase shares at a fixed price, where that right vests over time. With shares, you own equity immediately (subject to vesting). With options, you have the right to buy equity after vesting and exercise.
Can vesting terms be negotiated?
Yes, vesting terms are negotiable, especially for founders and senior hires. Common negotiations include: shorter vesting periods, credit for prior service, acceleration clauses, and good/bad leaver provisions. Employees have less leverage but should still understand and negotiate where possible.
What is reverse vesting?
Reverse vesting means shares are issued immediately but subject to a company repurchase right that lapses over time. Economically similar to standard vesting, reverse vesting allows founders to own shares upfront for tax and voting purposes while still being subject to vesting restrictions.
How does vesting work in an acquisition?
Vesting treatment in acquisition depends on deal terms and individual grant agreements. Options include: accelerated vesting, assumed grants continuing with new company, or cash-out of vested equity with forfeiture of unvested. Negotiate acceleration clauses before acquisition to protect your interests.