Vesting is a legal term referring to earning the right to a future payment, asset or benefit. An employee or founder gets rewarded for their time by receiving something, normally share options, over an agreed period, called a ‘vesting period’. A typical vesting period might be between three to five years. For a founder, it’ll be set out in a shareholders’ agreement; for employees it’ll be in an employment contract.
Coerce loyalty. Skin in the game. It’s a common part of the startup package to compensate for lower salaries and encourage people to stick around – key to a company’s success. VCs often invest in people, so it’s also a way of ensuring founder commitment.
This gives the recipient full ownership of what’s been agreed immediately. This might occur if another company buys the business.
Much more common, the recipient receives a percentage of the total after each year. A five-year schedule, for example, would result in 20% vested each year.
There’s a time period before the vesting comes into effect. So a schedule of four-year graded with one- year cliff (quite common) means the recipient only receives the first amount after one year.
Ifty Nasir is co-founder & CEO at Vestd, a share scheme and equity management platform for SMEs. Here he outlines what businesses should consider when setting up a vesting schedule.
What conditions will you set?
Vesting schedules are usually time-based, with options released over a defined period. However, you can also impose other conditions on the arrangement including performance milestones, which will unlock pre-agreed tranches of options when these metrics are reached. You’ll also need to decide what is the vesting frequency. This can be set to either monthly or annual for most schedules.
When can recipients turn the options into real shares?
Schemes can be ‘exercisable’ or ‘exit-only’. The former allows recipients to exercise on completion of their vesting schedule, whereas the latter requires an exit event before that can happen. That would typically be the sale of a company.
This article was first published in Courier Issue 34, April/May 2020. To purchase the issue or become a subscriber, head to our webshop.