Why Impose Vesting on Shares?

We are often asked about why we recommend imposing vesting on shares that are issued to founders, advisers and service providers, as opposed to granting stock outright. Imposing vesting on stock simply means that the recipient earns his or right to the stock by providing service to the company over time. A typical vesting schedule is four years with a one-year cliff. In that schedule, 25% of the shares vest after the recipient has provided a year of service, and then 1/36 of the remaining shares vest monthly until all of the shares have vested after four years.

Imposing vesting on shares protects the company and provides the recipient with an incentive to provide continued service. Take an extreme example:a company with 12M shares issues 4M fully-vested shares to each of three founders. The day after the shares are issued, one of the founders leaves, taking 1/3 of the company with him. If those shares had been subject to vesting, the founder would have taken none of the company with him. Take another example: a mature company gives 5% of its shares to a new CTO. Three months in, the company finds out the CTO is a bad fit for the company. If a four-year vesting schedule with a one-year cliff had been imposed, the company could get rid of the CTO and keep that 5%. With no cliff, the bad CTO gets to be a 5% owner in the company – not an ideal situation, especially if relations are strained between the CTO and the company.

Vesting also provides service providers an incentive to stay with the company, which can really help companies especially when the job market for that particular skill set is tight. However, vesting alone may not keep someone around, especially if the company is not doing well and the stock does not have much value.

Because imposing vesting on shares can promote the stability of a company, investors will want to see that shares that the company has issued are subject to vesting. If you are interested in positioning your company well for investment, it’s a good idea to put a vesting schedule on all shares that your company issues.

- Claire Kalia

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