Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
On this page
Share this post
Introduction
Ready to explore the exciting and complex world of employee equity vesting? This isn't just for the finance geeks — this is for anyone who’s ever wondered, "What is a vesting schedule?" or "How does this stock option thing work?" Stay with us, we’re going to break it all down for you.
What is Employee Equity Vesting?
First things first: what exactly is employee equity vesting? Imagine you’re given a treasure chest full of gold coins, but there’s a catch—you can’t take all the coins out at once. Instead, you can only take a handful every year. That's vesting. It’s a way for companies to give you a piece of the pie (or stock, or options, or equity) gradually over time.
Vesting means you earn the right to ownership of your equity over a period of time. It’s like a long-term relationship with your company, where trust and commitment grow. The longer you stay, the more equity you earn.
Types of Vesting Schedules
Now, let’s get into the details of vesting schedules. There are quite a few different ones, but we’ll break them down without making your eyes hurt.
1. Cliff Only Vesting
Think of cliff vesting like a dramatic movie reveal. Nothing, nothing, nothing... BAM! You get a chunk of equity all at once. You don’t get anything until you hit this milestone, called the cliff which can be a year, or more, or less.
Example: You’ve got stock options that vest in one year with a one-year cliff. This means you get nothing during the first year, and then —surprise!— 100% of your options vest at once on your first year anniversary.
2. Graded Vesting
Graded vesting is like getting a steady drip of caffeine to keep you awake throughout a boring meeting. You vest a little bit at a time, usually every month or every quarter. It’s predictable and consistent.
Example: Your stock options vest over four years with graded vesting. Each month, a small portion (1/48th) of your options vest. By the end of the four years, you’re fully vested.
3. Graded Vesting with a Cliff - the Most Common Vesting Schedule
This hybrid vesting is the best of both worlds and the most common vesting schedule for employees. It starts with a cliff and then moves to a graded schedule. It’s like getting a big bonus upfront and then steady payments after that.
Example: You’ve got a one-year cliff after which 25% of your options vest, followed by monthly (1/48th) vesting for the remaining four years.
4. Performance-Based Vesting
This is where things get spicy. Performance-based vesting means your equity vests when you or the company hits certain goals. It’s a way to align your interests with the company’s success. It’s like a game where you unlock rewards by hitting targets.
Example: You vest 50% of your options when the company hits $1 million in revenue and the another 50% when you complete a major project.
5. Back Loaded Vesting
Back loaded vesting is a bit mean. Instead of getting your rewards sprinkled evenly over time, you get the big payoff closer to the end of your vesting period. It’s like a marathon where the juiciest refreshments are at the last mile marker.
Example: Imagine you have stock options that vest over four years with a back loaded schedule. In the first two years, only a small portion (10%) of your options vest. But in the last two years, the remaining 90% of your options vest, with a significant chunk in the final year.
Back loaded vesting is all about rewarding loyalty and long-term commitment. It’s perfect for industries where sticking around and making a long-term impact really matters. This setup keeps you motivated to stay with the company, knowing that the biggest rewards are waiting for you down the line. It helps companies reduce turnover and keep the team stable, making sure everyone’s working towards the long-term goals together.
6. Reversed Vesting
With reversed vesting, founders (or key employees) start with all their shares vested upfront, but if they leave the company before the reversed vesting schedule ends, they lose ownership of some of the shares they already held. It's like starting a race with the prize in hand, but you have to keep running to hold onto it. This type of vesting is most commonly used with founders.
Example: A founder of a startup receives all their shares at the start with a four-year reversed vesting schedule. If they leave after 2 years, they would lose half the shares they already held.
Reversed vesting is a common way to make sure founders are shareholders with decision-making power upfront. This type of vesting makes sure that if any of the founders wish to leave too early, then they won’t stay as major shareholders.
7. Accelerated Vesting
Accelerated vesting is like getting a fast pass to your equity. This happens when all or part of the unvested shares become vested sooner than the original schedule, often triggered by significant events such as a merger, acquisition, or IPO.
Example: You’re working at a startup with a four-year vesting schedule. After two years, your company gets acquired. Thanks to an accelerated vesting clause, instead of waiting two more years for the rest of your options to vest, they vest immediately upon acquisition. You’re suddenly holding all your shares ahead of schedule, ready to cash in.
What is the Best Practice Around the World?
Companies everywhere around the world have their own ways of doing things.
In the United States, the most common vesting schedule is four years with a one-year cliff. This means companies want you to stick around for at least a year before you get any equity. After that, it’s monthly or quarterly vesting.
As employee equity originates from the United States, and gained its popularity with the rise of Silicon Valley and stock options, then actually most of the world has shaped their employee equity plans similarly to the United States. The four years with a one year cliff is the most popular choice also in Canada, the United Kingdom, Australia, India, Estonia, the Netherlands and France. There aren’t many countries which do not follow this approach.
However, in Japan, employee stock options and vesting schedules can significantly differ from the standard practices seen in the United States and many Western countries. Japanese companies often prefer longer-term and more conservative approaches to employee retention, and the concept of stock options itself is relatively newer and less widespread. As a result, vesting schedules in Japan may involve longer periods without a cliff, or more continuous and gradual vesting, reflecting a different cultural and business environment.
Nevertheless, even in the countries where the 4 year with a 1 year cliff is mostly used, it is common to see companies come up with their own plans to create a workplace culture that works for them. Thus, you will also find 1 year plans with no cliff, 3 year plans with a 1 year cliff, and even 5 year plans.
Different Possibilities and Why They Matter
So, why does any of this matter? Why should you care about how and when your equity vests? Let’s break it down.
Retention
Vesting is a clever way for companies to keep you around. They want you to stay long enough to be worth the investment. It’s like a relationship where you get better presents the longer you stay.
Motivation
Different vesting schedules can be a big motivator. Performance-based vesting, for example, can light a fire under you to hit those targets and unlock more equity. It’s a win-win: you’re motivated to do your best, and the company benefits from your hard work.
Financial Planning
Understanding your vesting schedule helps you plan your financial future. Knowing when your equity vests lets you anticipate when you can exercise or cash in, whether it’s for a down payment on a house, a dream vacation, or a safety net for the future.
Tax Implications
Don’t forget taxes! Different vesting schedules can impact how and when you’re taxed on your equity. For instance, in some countries, you might be able to take advantage of long-term capital gains tax rates if you hold onto your equity long enough.
Resources for Further Reading
Want to dive deeper into the world of equity vesting? Check out these resources:
- How to Grant Stock Options to Foreign Employees – 2024-ready Guide
- Good v.s. Bad Leavers – Clauses Explained for Startups
- Equity v.s. Salary – Which One to Choose in 2024?
Conclusion
Employee equity vesting doesn’t have to be a mystery. Whether you’re a startup star, a goal-getter or a strategic engineer understanding your vesting schedule can help you make the most of your equity. So, next time you’re handed a pile of paperwork with words like “cliff” and “vesting schedule,” you can smile knowingly and say, “I got this.” Happy vesting!
