27 Jan Understanding Equity Vesting in Startups
Equity vesting in startups is a critical concept for founders and employees to understand. It is a process by which ownership of a company is gradually transferred to an individual over time, typically in the form of stock options or restricted stock units (RSUs). The purpose of equity vesting is to align the interests of the founder or employee with those of the company, and to provide a retention incentive for key individuals to stay with the company over the long term.
One of the most common forms of equity vesting is the four-year cliff vesting schedule, which requires an individual to work at a company for a certain period of time before they become fully vested in their equity. For example, a founder or employee may be required to work at a company for four years before they become fully vested in their equity. After the four-year period, the individual becomes 100% vested in their equity, meaning they have the right to exercise their stock options or sell their RSUs.
Another common form of equity vesting is the graded vesting schedule, which allows an individual to become partially vested in their equity over time. For example, an employee may be 20% vested after one year, 40% vested after two years, and so on, until they become fully vested after four years. This type of vesting schedule is often used to provide a retention incentive for employees, as it encourages them to stay with the company for a longer period of time in order to fully vest in their equity.
There are also different types of vesting triggers that can be used to determine when an individual becomes fully vested in their equity. For example, a company may use a “time-based” vesting trigger, which means that an individual becomes fully vested in their equity after a certain period of time. Alternatively, a company may use a “performance-based” vesting trigger, which means that an individual becomes fully vested in their equity based on the achievement of certain performance milestones.
It is important to note that equity vesting is typically subject to certain conditions, such as the individual’s continued employment with the company. If an individual leaves the company before they become fully vested in their equity, they may forfeit some or all of their unvested equity. This is known as “repayment” or “clawback” provision.
In summary, equity vesting is an important aspect of startup culture as it aligns the interests of the founder or employee with those of the company and provides a retention incentive for key individuals to stay with the company over the long term. There are several different types of vesting schedules and triggers that can be used, and it is important for founders and employees to understand the terms of their equity vesting in order to make informed decisions about their ownership in the company.