UNVEILING “VESTING OF SHARES” AS STARTUPS PRIME TOOL FOR RETAINING TOP TALENS

In this article we are introducing the basics of vesting. This is the process by  which an employee, founder, or other stakeholder gains full ownership of their stock options or equity over a predefined period or upon meeting specific milestones. The mechanism is commonly used in startups and corporations to incentivize long-term commitment and performance.

Key Features of Share Vesting

Vesting Schedule is the timeline over which shares become vested. It typically includes “cliff vesting” which is an initial period during which no shares vest. Once this period ends, a large portion of shares vest all at once. Common cliff periods are one year. After the cliff period, shares vest gradually, often monthly or quarterly, until the end of the vesting, which is “graded vesting”. Common vesting periods range from 3 to 5 years.

Types of Vesting

For the purpose of this article, we will introduce to you two types of vesting. “Time-based Vesting” means that shares vest over time according to a set schedule. and “Performance-based Vesting” means that shares vest when specific performance goals or milestones are met.

“Acceleration Clause” is commonly used provision that allows faster vesting in certain situations, such as a company acquisition or the employee’s termination without cause.

Forfeiture happens  if employee leaves the company before their shares are fully vested, they forfeit the unvested shares back to the company.

Benefits of Share Vesting

Vesting encourages employees to stay with the company longer to receive their full equity. It aligns employees’ interests with the company’s success and growth. For startups, vesting ensures that founders remain committed to the company over the long term. By understanding the mechanics and benefits of share vesting, companies can effectively motivate and retain talent while ensuring sustained growth and stability.

Example of Vesting in a Startup

Scenario: A startup grants an employee 10,000 stock options with a four-year vesting schedule, including a one-year cliff.

• Year 1 (Cliff Period): No options vest during the first year. At the end of year one, 25% of the options (2,500 options) vest all at once.
• Years 2-4 (Graded Vesting): After the cliff period, the remaining options vest monthly over the next three years. This means that approximately 208 options vest each month (7,500 options / 36 months).

Facebook case

When Facebook was in its early stages, it used share vesting as a key component of its compensation strategy to attract and retain top talent. Mark Zuckerberg and other founders structured vesting schedules to ensure that early employees and executives would remain with the company through its critical growth phases.

Early founders, including Zuckerberg, had their shares subject to vesting schedules to ensure their long-term commitment to the company. Later on, Facebook offered stock options with vesting schedules to its employees, which became highly valuable after the company’s IPO in 2012. This approach helped Facebook retain key employees who contributed to its rapid growth and success.