Definition
Vesting determines when equity granted to a founder, employee, adviser, or other eligible recipient becomes earned under the terms of the relevant agreement.
It is commonly used for:
Founder shares
Stock options
Restricted shares
Other equity compensation
A vesting schedule can help align a person's continued involvement with their long-term equity entitlement.
Vesting does not necessarily mean that shares are issued gradually. Depending on the instrument and legal structure, the recipient may receive the shares upfront but remain subject to vesting, repurchase, forfeiture, or other restrictions.
How does vesting work?
A company may grant an employee:
40,000 stock options
subject to a four-year vesting schedule.
Under a simplified schedule, the employee earns the right to 10,000 options per year.
After:
1 year: 10,000 vested
2 years: 20,000 vested
3 years: 30,000 vested
4 years: 40,000 vested
The exact schedule can differ depending on the agreement.
What is a vesting schedule?
A vesting schedule specifies when and under what conditions equity becomes vested.
It can be based on:
Time
Employment or service
Performance
Company milestones
A combination of conditions
Time-based vesting is common in startup equity compensation.
What is a cliff?
A cliff is a period at the beginning of a vesting schedule during which no equity becomes vested.
For example, a four-year vesting schedule with a one-year cliff could work as follows:
Months 1–11:
0% vested
Month 12:
25% vested
Months 13–48:
Remaining 75% vests progressively
If the recipient leaves before the one-year cliff, they may receive no vested portion under the agreement.
Why do startups use vesting?
Vesting can help companies:
Retain talent
Equity becomes more valuable to the recipient as additional portions vest.
Align incentives
Recipients have an incentive to contribute to the company's long-term development.
Protect the company from premature departures
A person who leaves early may not retain equity that has not yet vested.
Protect against founder departures
Founder vesting can help prevent a situation where a founder leaves early while retaining a large ownership position.
Founder vesting
Founders may also have vesting arrangements.
For example, two founders might each receive:
500,000 shares
subject to four-year vesting.
If one founder leaves after one year, the company's agreements may allow the company or other shareholders to recover or repurchase some of the unvested shares, depending on the legal structure and documents.
This can help prevent a departed founder from retaining a disproportionately large ownership interest despite having contributed for only a short period.
Vesting vs. ownership
Vesting and ownership are not necessarily the same thing.
A person may have received shares but have those shares subject to vesting or repurchase provisions.
Similarly, an employee may have stock options that are granted but not yet vested.
Therefore, when evaluating an equity position, it is important to distinguish between:
Granted equity
Vested equity
Unvested equity
Exercised equity
Fully diluted ownership
Vesting and stock options
Stock options are commonly subject to vesting.
For example:
Grant: 100,000 options
Vesting: 4 years
Cliff: 1 year
After the first year, a portion becomes vested.
The remaining options continue to vest according to the agreed schedule.
The employee may then exercise vested options according to the terms of the option plan and grant.
What happens when someone leaves?
The treatment of vested and unvested equity depends on the relevant agreements and applicable law.
Typically:
Unvested equity may be forfeited or subject to repurchase.
Vested stock options may remain exercisable for a specified period.
Different rules may apply depending on why the person left.
Change-of-control provisions may affect the outcome.
There is no universal rule that applies to every company or jurisdiction.
Single-trigger and double-trigger acceleration
Some equity agreements provide for vesting acceleration when a company experiences a significant event, such as an acquisition.
Single-trigger acceleration
Vesting accelerates when a specified event occurs, such as a change of control.
Double-trigger acceleration
Two conditions must generally occur, such as:
A change of control
The employee subsequently loses their position or experiences another specified adverse employment event
The exact definitions and consequences depend on the agreement.
Vesting and dilution
Vesting itself does not necessarily create dilution.
However, equity that is subject to vesting can still form part of the company's capitalisation depending on the instrument and calculation being used.
For stock options, exercising vested options can result in shares being issued and therefore affect other shareholders' ownership percentages.
Example
A startup grants a founder:
1,000,000 shares
subject to four-year vesting with a one-year cliff.
After one year, 25% becomes vested.
The founder therefore has:
250,000 vested shares
The remaining:
750,000 shares
remain subject to the vesting arrangement.
If the founder leaves after the first year, the treatment of the remaining unvested shares depends on the company's legal agreements.
Common misconception
Vesting means you receive new shares every month.
Not necessarily.
Vesting describes when equity becomes earned or no longer subject to specified vesting restrictions.
Depending on the structure, the shares may already have been issued but remain subject to vesting or repurchase provisions.
Stock options work differently because the recipient generally has a right to acquire shares only after satisfying the relevant vesting conditions and exercising the options.
