What is a Stock Vesting Schedule?

A stock vesting schedule is a schedule or table that outlines the time period and requirements for stock to vest (become fully owned by the individual awarded the stock or option). 

Vesting is when ownership of something is fully established. Businesses often compensate employees by awarding them stock or stock options that are subject to vesting. That is, the stock will not be fully owned by the employee until the terms of vesting have been satisfied. 

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What is a Common Vesting Period for Stocks or Options? 

Founders generally reserve some form of founders stock for themselves. Startups use stock or options to compensate employees or independent contractors.  

Ownership of these shares or options may not vest at the time they are awarded; rather, it may be made subject to a vesting schedule. A common vesting schedule is that shares will vest fully over 3-4 years. 

What is Cliff Vesting? 

There is commonly a cliff or time frame before any shares will vest. For example, the first lot of shares may not vest until 6-12 months of services. At the point of 12 months, all the shares vest at one time - like falling off a cliff. 

What is Periodic Vesting?

Afterwards, the shares may vest monthly or quarterly. The start date for determining the vest date can be the date that the shares are issued or it can be an earlier date. Sometimes the founders will identify an earlier date to account for the work already invested in the business.

What is Milestone Vesting? 

The company may make stock or options subject to milestone vesting. This means that the awardee or the company must accomplish certain benchmarks or milestones before the shares or options will vest. 

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How does a Vesting Schedule Protect the Company? 

The vesting schedule protects the corporation in the event the founder decides to exit the corporation. If the shares have not yet vested, then the shares are either forfeited or the corporation is responsible for repurchasing them from the exiting founder. 

The requirement for the company to repurchase the shares of exiting shareholders is generally contained within the bylaws and the subject of a buy-sell agreement between the shareholders and the corporation. 

Equity investors will generally require that stock awards to founders or new employees be subject to such a vesting schedule. This prevents the issue of significant shares of the business being held by third parties who are not materially involved in the business. 

Founders, on the other hand, will seek to have unvested shares to vest upon exit or termination from the business. The middle ground is that the shares vest if the founder is terminated without cause and they are forfeited if the founder leaves or is terminated for cause. 

Of course, the for cause and without cause classification can cause serious disputes between founders and the business.

• Note: A middle ground between full vesting and no vesting is partial vesting. Acceleration of vesting for without cause termination may be a partial acceleration of say 3-12 months. This amount may constitute a valid severance package for the departing founder, as most startups have a buy-sell agreement in place that requires the corporation to immediately repurchase outstanding shares upon the separation of a shareholder.

What is Change of Control Vesting Provision? 

The founders may want all unvested shares to vest at the time of investment in order to add increased certainty to the capitalization calculation. This is known as a change-of-control vesting provision. 

It is triggered when either the business is sold or equity investors acquire a controlling interest in the company. 

This provision protects the founders in the event that the investors influence will seek or cause the founder to leave the business. 

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Investors do not favor these provisions, as it may diminish the incentive that the founders have in working for the business. 

The corporation may need to offer options or some form of earn-out arrangement to incentivize the continued performance of these founder employees. 

Limitations on the Change of Control Vesting Provisions?

Investors will also argue for increased stipulations on the change-of-control vesting provision. For example, the investor may include a requirement that the founder is fired without cause or that the conditions effectively force the founder out of the business within a stated period following the change of control. 

Effectively forcing out a founder/employee is known as Constructive Termination.

• Note: Expect investors to force a vesting schedule onto founders as a condition at the time of financing.