Young companies are often advised on the benefits of incorporating vesting into their reward structures. Vesting is a crucial tool for start-ups looking to attract, retain, and motivate employees and can help build a successful and sustainable company.
How can one best explain Vesting?
Vesting is a way to gradually acquire ownership of an asset, typically stock in a company. Think of it like this: you receive a certain number of shares of stock, but you can't sell or exercise control over all of those shares right away. Instead, you have to wait a certain amount of time, or meet certain conditions, before you become fully vested, meaning you have complete ownership and control over the shares. This is a way to incentivize employees to stay with a company for a certain period of time and to align their interests with those of the company. Once you're fully vested, you can sell your shares or exercise any other rights associated with ownership.
Part of the game, vesting criteria
Vesting usually follows one of three criteria: reaching a specific goal, working for a set period of time, or a combination of both. For instance, if the vesting criteria is based on reaching a milestone, you will become fully vested in the asset once the company reaches that goal, such as going public or hitting a performance target. If the vesting period is set for three years, then you will have to wait three years before you fully own the asset. These criteria ensure that both the recipient and the company have a vested interest in the asset's success.
The three most common ways to Vest: Cliff, Graded, and Immediate
Cliff vesting means you have to work for the company for a certain length of time before you become fully vested in the asset. With graded vesting, you gradually become entitled to a larger percentage of the asset over time. Immediate vesting is the quickest way to become fully vested, as you don't have to wait at all before gaining ownership of the asset. This is less common compared to cliff and graded vesting.
How Cliff Vesting works: An Example
Let's say you want to give your employees a gift of 300 shares of stock. With a 3-year cliff vesting schedule, your employees wouldn't be able to buy these shares for three whole years. But after that waiting period, they can finally buy the shares at the agreed-upon price and sell them if they'd like.
Graded Vesting: An Example
Let's say you want to offer your employees a gift of 300 shares of stock again, but this time with a graded vesting period of 6 years. This means that after the first year, your employees will receive 60 shares, which is 20% of the total. These 60 shares will be fully theirs and they can buy and sell them if they choose to. The next year, they will receive another 60 shares, and so on until they have received all 300 shares after 6 years. That's how graded vesting works!
Instant Ownership with immediate vesting: An Example
If you want your employees to have the freedom to do what they want with their shares right away, you can offer them immediate vesting.
Consequences of leaving early
Let's say you offer your employees a stock option of 300 shares, with a 3-year cliff vesting schedule. If they decide to leave the company before the 3 years are up, they will not be able to keep any of the shares. This is why it's important for employees to consider their departure date in order to make the most of their vested equity if they believe the company's stock is valuable. As an employer, it's crucial to set a fair vesting schedule to motivate your employees to stay with the company.
Use a lawyer in complex situations
The benefits of incorporating vesting into a start-up's reward structure include attracting and retaining top talent, aligning interests, and encouraging commitment. Vesting can also be combined with other reward structures, such as stock options, restricted stock units (RSUs), and bonuses, to create a comprehensive compensation plan.
In conclusion, vesting is a valuable tool for start-ups and should be considered when designing a reward structure. A qualified start-up lawyer can provide advice and guidance on incorporating vesting and other components into a comprehensive compensation plan for the benefit of the company and its employees.