Vesting Basics – What are typical vesting schemes?

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Vesting Basics – What are typical vesting schemes?

In a previous Founder Tip of the Week, I discussed what vesting is. In this Founder Tip of the Week, I will discuss some common vesting schemes.

Employees

The norm for options granted to employees is that they vest ratably monthly over four years.  In other words, 1/48 of the shares issuable pursuant to such an option vest every month that the optionee renders services to the company until all of the shares have vested after 48 months.

Options granted to new employees (as opposed to long-standing employees) will often be subject to a six- or 12-month “cliff.”  By way of example, an option that vests ratably monthly over 48 months with a six-month cliff will not vest with respect to the first 6/48 of the shares issuable pursuant to such option until the optionee has rendered six months of continuous service to the company.  Among other matters, cliffs help companies avoid having to issue stock to optionees that do not work out and may be hostile to the company.

Consultants

The vesting for consultants varies depending on the engagement.  A consultant engaged to perform services for 12 months would generally be granted an option that vests ratably monthly over 12 months.  Options granted to consultants sometimes have cliffs.

If the duration of the consultant’s engagement is unknown or if the engagement involves a project with deliverables, the vesting can be based on the achievement of milestones.  By way of example, if a consultant is granted an option for 40,000 shares and the engagement calls for the consultant to produce four deliverables, the option could provide that 5,000 shares will vest upon the consultant’s delivery of each of the first three deliverables and that the balance of the shares will vest upon the consultant’s delivery of the fourth and final deliverable.

Directors

As with employees, the norm for options granted to directors is that they vest ratably monthly over four years.  However, because directors are often-times luminaries in their fields that are highly sought after and therefore have leverage, directors can often negotiate shorter vesting terms.  It is not uncommon for options granted to directors to vest ratably monthly over three years or even two years.  In addition, director options will often-times provide that a portion or all of the shares will immediately vest (the vesting “accelerates”) upon a “change of control” of the company (i.e., a sale of the company).  Options granted to new directors (as opposed to long-standing directors) sometimes have cliffs.

Advisors

As with employees, the norm for options granted to advisors is that they vest ratably monthly over four years.  However, like directors, advisors sometimes have the leverage to negotiate shorter vesting terms, so the vesting term can be three years or even two years.  Also as with director options, advisor options will sometimes provide that vesting accelerates with respect to a portion or all of the shares upon a change of control of the company.  Options granted to new advisors (as opposed to long-standing advisors) sometimes have cliffs.

Founders

The starting point for founders stock is that it generally vests ratably monthly over four years, like employee options.  However, founders stock vesting schemes vary widely, particularly where one or more founders contributes valuable intellectual property to the company at incorporation of the company or has been working on the business of the company for a significant amount of time prior to incorporation.  Such founders will often have a portion of their shares vested up front.

Just as an example, let’s say that a founder contributes a valuable patent to the company and the founder is purchasing 2,000,000 shares of founders stock.  A possible vesting scheme would be for some of that founder’s stock to be vested at the time of purchase (in return for the patent) and for the balance of the shares to vest ratably monthly over 48 months.  Or let’s say that the same founder spent one year working on the patent, and he or she wants to be given credit for that year.  An alternative would be for 500,000 shares of founders stock to be vested at the time of purchase (500,000 shares is 12 months of vesting under a ratable monthly four-year vesting scheme) and for the balance of the shares (1,500,000 shares) to vest ratably monthly over 36 months, so that the founder’s vesting essentially commenced one year prior to incorporation of the company.

Founders stock is not generally subject to cliffs.  However, when a company has more than one founder, and particularly when such founders do not have a history of working together, the stock of some or all of the founders may be made subject to a cliff.  As mentioned above, cliffs help companies avoid having stock end up in the hands of persons that do not work out and may be hostile to the company.

The terms of founders stock will generally provide that vesting accelerates with respect to a portion or all of the shares upon a change of control of the company.  Sometimes such accelerated vesting will be conditioned upon the founder being terminated by the company other than for “cause” in connection with the change of control, which is referred to as “double trigger” acceleration.

Whatever vesting schemes founders settle upon, the vesting schemes should be reasonable, particularly if they plan to seek venture capital financing.  A venture capitalist is likely to leave in place a reasonable vesting scheme that aligns the company’s and the founder’s interests, but if the vesting scheme needs to be renegotiated, it is not uncommon for venture capitalists to reset the clock and insist on four-year vesting commencing from the closing of the financing.

The vesting terms I discussed above are baselines.  For example, some companies use three-year or five-year vesting for employees and others across the board.  There may also be regional variations as well.  Finally, as I called out with respect to director and advisor vesting, some individuals have the leverage to negotiate shorter or otherwise more favorable vesting schemes.