Employee Equity: Vesting

We had a bunch of questions about vesting in the comments to last week’s MBA Mondays post. So this post is going to be about vesting.

Vesting is the technique used to allow employees to earn their equity over time. You could grant stock or options on a regular basis and accomplish something similar, but that has all sorts of complications and is not ideal. So instead companies grant stock or options upfront when the employee is hired and vest the stock over a set period of time. Companies also grant stock and options to employees after they have been employed for a number of years. These are called retention grants and they also use vesting.

Vesting works a little differently for stock and options. In the case of options, you are granted a fixed number of options but they only become yours as you vest. In the case of stock, you are issued the entire amount of stock and you technically own all of it but you are subject to a repurchase right on the unvested amount. While these are slightly different techniques, the effect is the same. You earn your stock or options over a fixed period of time.

Vesting periods are not standard but I prefer a four year vest with a retention grant after two years of service. That way no employee is more than half vested on their entire equity position. Another approach is to go with a shorter vesting period, like three years, and do the retention grants as the employee becomes fully vested on the original grant.  I like that approach less because there is a period of time when the employee is close to fully vested on their entire equity position. It is also true that four year vesting grants tend to be slightly larger than three year vesting grants and I like the idea of a larger grant size.

If you are an employee, the thing to focus on is how many stock or options you vest into every year. The size of the grant is important but the annual vesting amount is really your equity based compensation amount.

Most vesting schedules come with a one year cliff vest. That means you have to be employed for one full year before you vest into any of your stock or options. When the first year anniversary happens, you will vest a lump sum equal to one year’s worth of equity and normally the vesting schedule will be monthly or quarterly after that. Cliff vesting is not well understood but it is very common. The reason for the one year cliff is to protect the company and its shareholders (including the employees) from a bad hire which gets a huge grant of stock or options but proves to be a mistake right away. A cliff vest allows the company to move the bad hire out of the company without any dilution.

There are a couple things about cliff vesting worth discussing. First, if you are close to an employee’s anniversary and decide to move them out of the company, you should vest some of their equity even though you are not required to do so. If it took you a year to figure out it was a bad hire then there is some blame on everyone and it is just bad faith to fire someone on the cusp of a cliff vesting event and not vest some stock. It may have been a bad hire but a year is a meaningful amount of employment and should be recognized.

The second thing about cliff vesting that is problematic is if a sale happens during the first year of employment. I believe that the cliff should not apply if the sale happens in the first year of employment. When you sell a company, you want everyone to get to go to the “pay window” as JLM calls it. And so the cliff should not apply in a sale event.

And now that we are talking about a sale event, there are some important things to know about vesting upon change of control.  When a sale event happens, your vested stock or options will become liquid (or at least will be “sold” for cash or exchanged for acquirer’s securities). Your unvested stock and options will not. Many times the acquirer assumes the stock or option plan and your unvested equity will become unvested equity in the acquirer and will continue to vest on your established schedule.

So sometimes a company will offer accelerated vesting upon a change of control to certain employees. This is not generally done for the everyday hire. But it is commonly done for employees that are likely going to be extraneous in a sale transaction. CFOs and General Counsels are good examples of such employees. It is also true that many founders and early key hires negotiate for acceleration upon change of control. I advise our companies to be very careful about agreeing to acceleration upon change of control. I’ve seen these provisions become very painful and difficult to deal with in sale transactions in the past.

And I also advise our companies to avoid full acceleration upon change of control and to use a “double trigger.” I will explain both. Full acceleration upon change of control means all of your unvested stock becomes vested. That’s generally a bad idea. But an acceleration of one year of unvested stock upon change of control is not a bad idea for certain key employees, particularly if they are likely to be without a good role in the acquirer’s organization. The double trigger means two things have to happen in order to get the acceleration. The first is the change of control. The second is a termination or a proposed role that is a demotion (which would likely lead to the employee leaving).

I know that all of this, particularly the change of control stuff, is complicated. If there is anything I’ve come to realize from writing these employee equity posts, it is that employee equity is a complex topic with a lot of pitfalls for everyone. I hope this post has made the topic of vesting at least a little bit easier to understand. The comment threads to these MBA Mondays posts have been terrific and I am sure there is even more to be learned about vesting in the comments to this post.



#MBA Mondays

Comments (Archived):

  1. scyphers

    What do you think about balloon vesting schedules (i.e. 10% the first year, 15% the second, 25% the third and 50% the final year)? I’m strongly considering this for my current startup as a way to incentivize the longer term retention of key employees…

    1. gyardley

      Less employee-friendly than the standard four years with a one-year cliff, so it’d probably act as a minor impediment to hiring.

    2. Kurt Schrader

      As an employee of many start-ups over the years, I’d have a hard time agreeing to something like this. I personally feel like I’d get screwed if an acquisition occurred during the first three years. You’d have to combine it with some pretty strong acceleration clauses in order for me to get comfortable with it.

      1. scyphers

        As a startup veteran myself (this will be my 7th (?!) but first time as founder), I agree. There will be an acceleration clause for just that reason.

      2. Guillermo Ramos Venturatis.com

        Vesting is a retention & tax tool, but the reward is not vesting but the stocks/options. The reward is subject to getting to an expected value in a defined time, so the acceleration should only apply if the expectations are met in terms of value&time.

        1. Kurt Schrader

          That’s true, but I don’t think that it’s unfair to say that most of us have a mental model of how options normally work.Why would I be rewarded with 5 times the number of options in my 4th year than in my first year? Is the work I’m doing suddenly 5 times more valuable?Just like I wouldn’t accept a balloon compensation schedule without some guarantees in place (if at all), I don’t think that I’d be comfortable with a vesting schedule that looks like this.The more I think about this plan, the less likely I feel like I’d go to work someplace with a plan like this. If your goal is to “incentivize the longer term retention of key employees” then I think that it can be done more appropriately with follow-on grants.

          1. Guillermo Ramos Venturatis.com

            The rationale for having stock/options is to reward extraordinary talent/performance (the ordinary one is called payroll). Any provision that jeopardizes this, is not fair. Having said that, if you leave the company after 2 years, you may have contributed a lot to the company and you should be entitled to get some of the extraordinary value you have created, but on the other hand perhaps leaving too early could be seriously detrimental for the company. In that case, it may make sense the balloon scheme. Maybe good for certain type of companies were value shows up a bit late in time.

    3. charlessmith

      The biggest issue with that is the competitive nature of hiring talent for a startup, especially developer talent. All things being equal, a backloaded vesting schedule is a disadvantage. It also undervalues the early contribution, which I think would be a mistake.

      1. fredwilson

        yes, exactly

    4. Gautam Tambay

      Interesting way to make sure people are in it for the long haul. But with this schedule, you’ll almost certainly have to offer them accelerated vesting in case of change of control, no?

      1. scyphers

        Yes, there will be an acceleration clause in place for change of control.

    5. fredwilson

      i don’t love itit is not standard so some employees will resent it

  2. David Semeria

    How do you feel about founders being forced to put their (already owned) stock into a vesting schedule as a condition of financing?I suspect it doesn’t happen so much nowadays – but I would still be curious to hear your thoughts…

    1. Scott Barnett

      It’s just one piece of what a founder negotiates with the VC – so by itself it’s hard to say good or bad. On the one hand, if the founders own all their stock, the VC’s have no leverage if one (or more) of the founders want to walk away – they still own their share. On the other, did you see The Social Network? A founder can be heavily diluted out of his share if he is not careful.I happen to think the amount of time the founders have been working on their startup plays a big part in this – if I’ve already spent 4 years (for example) on my startup before I went for capital, then in my mind I’m already “vested”. If I’ve only spent 2 years, I’d be open to having the final 2 years vest over time. But having said that, the VC’s hold the cards – if you want their money, you have to play by their rules – and if they feel you pose a “flight risk” on their investment, regardless of how long you’ve been at it – they will want to put golden handcuffs on you.

      1. David Semeria

        I would guess the “right” answer to this question is that if founders set-up their company properly (with vesting at inception) then the VC shouldn’t need to tackle this issue.Of course, the financing could come after the remaining founders are fully vested – which is when it gets tricky,,,And no, I haven’t seen the Social Network yet.

        1. Scott Barnett

          Even if the founders setup the company with vesting at inception, the VC’s can institute vesting on the “new” shares when the round is done. And you should watch the movie, it was great.

          1. David Semeria

            Yes I know — and I’m not sure how I would react to that situation myself.Thanks for the movie recommendation, I fully intend to watch it when it opens in my neck of the woods.

        2. JLM

          Here is a little bit of advice I received a long, long time ago.Think of every investment as if it were going to fail and how it would have to be unwound before the money goes in.Plan for the impact on you personally, professionally and the impact it could have on your estate.I like to put some of the investment into a trust — get some advice on this — because it makes the other side believe that there is some portion of your stock which is beyond your ability to control.If your company should ever become public and you have to deal with SEC Forms 13D and 4, you may have a huge financial advantage by not having exercising direct dispositive control over some amount of your shares.

        3. fredwilson

          exactly

      2. JLM

        There are many ways for a VC to ensure that management remains stable including imposing an employment agreement — thereby transforming an arguably “at will” employment relationship into a contractual arrangement with non-performance penalties.In life we do not get what we deserve, we get what we negotiate.If you open Pandora’s Box as it relates to YOUR shares, you will suffer.

        1. Scott Barnett

          I’m with you! Love the deserve/negotiate line, and could not be more true. You negotiate for what you’ll need when things go sour – which is really hard to do when you’re in “love” and everything is looking up. That’s a skill I still have not mastered, but working hard on it!

          1. JLM

            Go to the Chester Karass Negotiating Seminar and read the materials.Negotiating is like putting, it just requires practice to become very, very, very good.When you are not good, it can really impact the final score.It is an earthy skill which can be mastered like digging for clams.

          2. Scott Barnett

            there’s a difference when negotiating a deal on behalf of your company vs. negotiating for yourself (at least there is for me). I don’t tend to have an issue with the former, it’s the latter that I find my emotions tend to get in the way.

          3. JLM

            The funny thing about life and business as a subset of life is that emotion is a good thing not a bad thing. It should not get in the way, it should fuel the outcome.Passion is an emotion as is fear. Both can be harnessed, by different folks, to influence the outcomes.I often find myself motivated by one or the other or both.You cannot take care of a business if you cannot simultaneously take care of yourself. and your family.I find that most entrepreneurs, because they are paid in a different currency than just $$$, are not demanding enough for themselves.Be kind and fair to yourself and demand full measure for your time, talent and perspiration. You deserve it, my friend!

          4. Dave Pinsen

            Does he still advertise in the in-flight magazines? Speaking of flying, I wonder what the frequent fliers here (the mortals who fly commercial, that is) think about the TSA’s latest escalation of passenger screening methods. If it stands, I think we’ve crossed a Rubicon as a country, and it won’t be long before we get the similar treatment at train stations, office buildings, etc.

          5. JLM

            The effectiveness of our current screening program is quite suspect. Of course, I think that ALL nuns should be hand searched just for fun. Make it a habit?

          6. ErikSchwartz

            Security theater.You want to make flying safer? Make pilots take breathalyzers or tests for exhaustion. That will make flying several orders of magnitude more safe than body scanning passengers.I guarantee you the American flying public is at far more risk from tired or drunk pilots than from terrorists.

          7. Dave Pinsen

            That wouldn’t address the terrorist threat, but there are ways of protecting against terrorism without making every law-abiding passenger miserable. Good take on what we could be doing differently by an Israeli aviation security expert: http://www.thestar.com/news

          8. ErikSchwartz

            So we’re wildly off topic…The reason Israel can do security the way they do is the scale. The US has about 30,000 commercial flights a day at dozens of major airports, Israel has a few hundred out of basically two airports.

          9. Dave Pinsen

            Nonsense. We have a lot more airports and flights, but we also have commensurately more resources than Israel. Scale isn’t why we aren’t taking an intelligent approach to aviation security.

          10. ErikSchwartz

            We’re miles off topic but I disagree with you here.There are about 13M commercial flights a year in the US. There are about 100K in Israel. That’s >1%. The US population is 300M, the population of Israel is about 7M. That’s about 2% of the US population. So per capita we have more than twice the number of flights. But about half of Israel’s flights originate outside the country (IE half of the flights are not screened at an israeli airport). In the US ~90% of flights are domestic (therefore 95% of US flights are screened at a US airport).Furthermore… Who does airport security in Israel? The IDF does. How does the IDF get all it’s manpower? Universal service. The US cannot use the military to do airport security (due to Posse Comitatus), even if the military had the manpower to do it.Look, no question airline security could be both better and less intrusive, but just like you can’t make a 100 foot tall ant, you can’t scale Israel’s airport security system to our scale. Yes there’s a solution, but the IDF’s is not it. It’s just a stalking horse argument.

          11. Dale Allyn

            I think a lot of us who travel for business are discussing this topic of late. And now, the press and blogoshpere are getting hold of it. I have composed a rather pointed letter to my Congressman (who is on several security committees/sub-committees) which I will be faxing to both of his offices, sending the hard copy to both, and emailing it to him today. I may paint it on his driveway. Not that any of this will do any good, but the current porno-scans are ridiculous. There are so many other ways to pass materials right under the TSA screeners’ noses that this invasive procedure does nothing but give terrorists a point. </rant>

          12. fredwilson

            i don’t agree JLMi was a better putter when i was younger and didn’t have the yipsi get better at negotiating as i get older

          13. JLM

            Which one have you practiced more?Both are skills which improve with a practice plan and serious practice.I bet you never practice putting but are negotiating something every single day of your life.But, hey, I could be wrong. LOLWhat we measure, we manage.What we practice, we improve.

      3. fredwilson

        agreed

    2. ErikSchwartz

      I personally won’t work with a co-founder who will not agree to founder vesting. Never mind the VCs, if you have multiple founders this is something you need. No need for a cliff in this case.You only need to get burned in this way once.

      1. David Semeria

        I agree Eric. The issue is more with a VC forcing you to vest again…

        1. fredwilson

          they don’t force founders to vest again.if the founders have been at it for three or four years by the time the VCs show up, it is a non issue

      2. Matt A. Myers

        Would the co-founders expect that same security with the ‘main founder’ – whereby it’s vested for them as well?… Or do they from your experience?Thanks

        1. ErikSchwartz

          All founders should vest.I have seen far too many times a situation where a co-founder is excited about the IDEA of starting a company, but when it comes to actually doing the work he or she can’t or won’t step up to the level needed.This situation is exacerbated when the startup scene gets frothy.

    3. JLM

      I get back to my consistent rant about stock options — they represent only one element of a balanced and rational compensation scheme particularly for the top management of a company.Cash compensation, bonuses, benefits, short term incentive comp and long term incentive comp all should be used to create the exact relationship the Board wants to have with the Company’s management.The Board’s Compensation Committee should do some thoughtful work to ensure that there is an attractive package, one that is properly rewarded and one that is properly motivated to succeed. This is not an easy thing to do but it is really the Comp Committee’s job to get it done.My experience is that Comp Committee’s are not very knowledgeable about real comp issues and they are pretty damn lazy and one dimensional. When done right, it can be a thing of beauty and it can truly motivate management.I have seen Boards that tailor a plan to perfection and I have seen clueless Boards who never give it a second thought.I think of compensation as being the nutrition for the brains and brawn I am hiring. I can get a bit more from them if it is done correctly and is truly customized. It takes just a bit more work to do it correctly. Just a bit more to do it brilliantly.I must also say that I like things to be what they are intended to be and not to be so subtle or unclear as to fail to achieve the real intention.I think long term incentive comp — ISOs and NQISOs — are golden handcuffs and I am a bit impatient with folks who want them to be such but are not willing to make them such.I like a 4-year cliff vesting in which they vest entirely at the end of 4 years and I like a few performance hurdles.I also believe in “negotiating” them with the recipients. After all, they are going to be perceived in a different way, why not help the perception along a bit.

      1. Guillermo Ramos Venturatis.com

        Stock/ Options are to start-ups what carry is to VCs: a reward for an extraordinary performance/talent.VCs get their carry provided they give LPs all their money back plus a minumum return. They normally have no vesting schemes (sometimes some exceptions but the net result is no vesting).Vesting for VCs is only used in good/bad leaver provisions (with cause or none). Early leavers with no cause normally don´t get any carry.The rationale should be: get the job done, so get the carry/ stocks-options.

        1. JLM

          Well played. Success makes all the horribles disappear.

        2. fredwilson

          i’m not entirely understanding this commentbut every VC carry provision i have ever seen and i have seen many has a ten year vest on it

          1. Guillermo Ramos Venturatis.com

            I have been working several years with the largest Fund of Funds investing in european VCs and here the cash flow cascade is: first return 100 % commitments to LPs, next hurdle rate for LPs, catch up, and 80/20 carry.Sometimes there is vesting but there is normally an escrow on it, so if there is only 95% return on comittments the escrow comes back to the investors. So “sometimes some exceptions but the NET result is no vesting”. So for a VC, is not posible to go to the “pay window” if they underperform.In the case of vesting options for some employees at a start up, this is not so clear. There is a very recent example of this about someone working for Facebook that apparently didn´t add the value he was supposed to although he went to the “pay window”. I hope I have expressed myself better now 😉

      2. Matt A. Myers

        It sounds easy enough until you try to factor in “what’s fair” in that moment. Maybe primarily that ends up being what people are willing to work for as well to keep them on, and then the real negotiating fun / headache begins?

        1. JLM

          Like anything, employees are “market driven” beasties and should be. Somebody who does not take care of themself is not going to take care of you and your company.You will find that an awful lot of negotiating is just getting the other party to articulate what they really want. The last three guys who I hired all wanted far less than I was prepared to give at that instant in time. They really negotiated their deal with themselves.

    4. fredwilson

      we insist on it. not for our benefit so much as for their benefit. just because three people started the company, it doesn’t mean two of them should be able to walk out the door a year later with all of their stock and leave the third founder holding the bag

  3. Guillermo Ramos Venturatis.com

    As vesting awarding within a team is done upfront, ie before the talent and effort is demonstrated: would it make sense to “retain” some (say 50%) of the stocks/options and reallocate it ex post to the best contributors within the team to the success?

    1. JLM

      Actually options are granted SUBJECT TO vesting provisions of the option grant.If an employee fails to vest, then he has still received the benefit of the bargain he has struck.It is not unheard of to award options from a pool of available options — I am doing that very thing just now — and I like the idea that the remaining option holders get all remaining options by default.

      1. Dale Allyn

        If I understand your point correctly, JLM, I love this idea. Establish a pool of available options for a specific team. Those who see it to the end share the pot. One can have named grants to each, plus a residual “crib” to split. This sounds like a great means to incentivize hires to stay on. I’ve done it with cash bonuses like this, but not equity. Thanks. Something to think about.

  4. aripap

    I’ve seen another variation: a vesting schedule where a tier of options accelerated vesting when either the company’s fair market value or exit price exceeded a certain threshold. This was the case in a private equity deal where the investors/owners had specific valuation ideas and wanted to incentivize management to hit them.

    1. markslater

      i’ve seen this. I’ve not seen it in equity though – i’ve seen it in traditional cash bonuses.like – we are buying for $10M if you get to a fair market value of $40M by XXX timeframe – then you receive YYY$.

    2. JLM

      This is simply “performance based” vesting as opposed to temporal vesting. I very much love performance based vesting as it is the truest measure of intentions.

  5. R.W.

    What do you think about reverse vesting with a buyback clause? The type where the employees have to file the 83b. This was popular in SF a year or so ago.

    1. JLM

      The decision to make an 83b election is a PERSONAL tax strategy and the Company should neither participate in, benefit from or hinder that decision because if the deal goes south, only the employee will be left holding the bag.

  6. awaldstein

    Fred… a great job on a difficult and convoluted and obviously critical topic.Most common in my experience is the 4-year vest, one-year cliff and full vesting on change of control for those that will most likely be let go…I include the CMO/VPs of Marketing in there. I believe in the double trigger as well, but it gets squishy especially when small companies get eaten up by larger ones and rank and reporting equivalents are a mush.The idea of vesting the full first year for all employees of covered by the plan if there is a change of control is a new one to me…but then I’ve never been in a change of control that actually executed during year one, for me at least. The fairness factor seems great though as a concept.Can you talk a bit more about the retention bonuses? Are you referring to additional grants with another 4 year vest, or something else?Thanks again for finding the time to hammer this out. Seems like the process of learning is never over for this topic.

  7. Portman Wills

    ” I advise our companies to be very careful about agreeing to acceleration upon change of control. I’ve seen these provisions become very painful and difficult to deal with in sale transactions in the past.”Any chance you could expound on that a bit in the comments or a future post?I understand that the acquiring company may not like it if a significant number of the employees have AVCoC, because the acquirer doesn’t want a bunch of employees to quit after the deal closes.However, as a casual observer, it seems to me like lots of employees quit ANYWAYS after the acquisition. The kinds of employees who are attracted to StartupCo are probably not the best fit for BigCo. BigCo should assume, in any acquisition, that some of the early employees are going to leave, and shouldn’t be using an ancient vesting schedule from a few years ago as a means to retain those employees.Thoughts?

    1. markslater

      this is easily handled.In a recently failed sale of my company – all key employee’s were interviewed and offer “positions” in the acquirer. Ok it was an asset sale so it makes this cleaner, but even with the sale of the on-going concern – there is a new employer / employee relationship that needs to be established.Its up to BigCO to make it attractive to key employees post close – its all part of the complexity of a sale.

    2. Harry DeMott

      The more employee options that are vested upon a change of control – the more costly it is in terms of actual cash out the door on an acquisition – and the less control you have over the employees you are acquiring. So, let’s say in an extreme example that 100% of the employees received full accelerated vesting on a change of control, the buyer could be faced with a situation where they needed to pay for 100% of all the shares – and then have 100% of the employees walk out the door! Usually, you want the key players to still have a lot of skin in the game – after all, you are likely buying the company not only for the products, but really for the team that developed them.

      1. JLM

        The acquiring company is not acquiring a “start up” and therefore is not entitled to the kind of employment relationships that exist in a start up.A Board who would favor one type of option holder — management — over another type of option holder, is going to have a very difficult time discharging their fiduciary obligations in a manner which will stand scrutiny.The acquirer is going to have to engage with the employees and create a “go forward” incentive plan to ensure management and key employee continuity. This is a critical element of any M & A activity and always has been so.

        1. wfjackson3

          I agree. If there is any negative impact, I would suspect that the acquirer is forced to value the company at the present and then incentivize everyone to stay with new options/grants and new vesting schedules in the new company. This might reduce the value they pay for the acquired company because they will have to pay for employee retention, but it also seems to be the thing that is most fair to the employees.

  8. Scott Barnett

    Fred, you talk about the morality issues of the one year cliff – if somebody has been with a company for just under a year when they get fired (at least that’s how I’m interpreting your example), you think they should still get some vesting, even though they legally didn’t earn it. So, what about making the vesting cliff 6 months? You don’t hear that mentioned often, but that seems reasonable to me – I guess the only downside is somebody could quit on 6 months + 1 day and you then owe them stock, but they didn’t contribute all that much.You didn’t explicitly mention it, but the main reason I’m aware for not putting acceleration on change of control is to reduce flight risks of key employees upon acquisition – are there others? The double trigger handles that pretty nicely, I think – no need to give anybody blanket acceleration, but if the acquiring company wants to get rid of you, then you get it. Fair trade. What’s the time horizon on the double trigger – one year? less?

    1. fredwilson

      yes, double trigger is mostly about flight risk

  9. Andrew C

    Great post! My question is, how do you decide how many options to allocate to each employee? Are there general rules of thumb about how much percent each employee should be allocated based on title? Or is it really up for negotiation?

    1. Pete Meehan

      Good question.

    2. fredwilson

      there are no rules of thumb. it depends on the stage of the company, the number of employees, the role and responsibility of the employee, etc.we have a methodology that i’ll blog about in the next mba mondays post

  10. markslater

    All very clearly explained Fred. It should be noted that whatever happens Vis-a Vie your own vest – you should be aware of the class of stock it becomes and how that relates to the rest of the cap table in a change of control situation. (convertible debt, preferred etc).

  11. Ethan Stone

    Great post. FYI, the four year vesting schedule is actually a relic of a California securities law regulation that was eliminated a few years ago. Four years used to be the longest you could go without having to go through an impractical state registration procedure. Now, you could go longer. No one seems inclined. Traditions die hard, I guess. Or maybe the California regulators were right and four years is optimal . . .A minor point that can become major if not dealt with properly is the definition of a change of control that triggers vesting. In addition to the double trigger, you need to be careful that the definition requires the change of control to be consummated. There are agreements out there (normally manager-driven agreements in public companies) that define a change of control as the point at which an agreement is signed or the board or shareholders approve, regardless of whether the deal closes. If you’re an employee with lots of leverage and you’re wondering what else you can ask for, of course, you might consider this (there’s some justification to wanting to be able to jump ship before the closing is actually consummated, especially if you know you’re likely to be canned immediately afterward). But the company shouldn’t agree to it without serious consideration.

    1. JLM

      If you think about it, four years is just about the natural sine/cosine wavelength of life. Look at your own life and tell me you cannot see the superimposed four year cycle.

  12. vinniv

    Solid post Fred. In a future post could you discuss the various tax implications of employees purchasing their vested stock and how it related to the timing of a liquidation event? AMT, cashless exercise, impacts of strike prices vs update valuations, etc.

    1. awaldstein

      AMT…now that’s a topic!

    2. Steve

      I agree, this would be a great follow-up post.

    3. fredwilson

      i will need a tax accountant to do itand thus it will be impossible to understandthat is a joke at some level

  13. klochner

    Can’t an earn-out take care of the accelerated vesting problem?

    1. fredwilson

      usually an earn out is in addition to the purchase pricethey are different things

  14. JLM

    Options are an incentive to stick it out and to share in the rewards for completing the mission.If the VCs are headed to the exit w/ a pocket full of loot, it is only fair that the employees and management who have made that possible are similarly rewarded with the same bountiful liquidity.The Laws of the Pay Window, abridged version:When anybody goes to the pay window, everybody goes to the pay window.If everybody cannot go to the pay window, then nobody goes to the pay window.Simple fair concept like the law of gravity.

  15. Ben

    “The second is a termination or a proposed role that is a demotion (which would likely lead to the employee leaving).”I agree in principle, but how do you define ‘demotion’, particularly upfront in a contract today for a hypothetical future acquisition?Your “vp biz dev” becomes an “account executive” in the new BigCo structure but keeps the same pay – is that a demotion? Your “software architect” keeps his title in the new BigCo structure but no longer has direct reports – is that a demotion?It all seems very qualitative. Fred, do you have any examples of wording you’ve used to cover/mitigate this in the past?

    1. fredwilson

      there is “boilerplate” language in most constructive termination provisionsgoogle the phrase “constructive termination” and see what comes up

  16. paramendra

    The topic remains quite unclear. 🙂

  17. harryh

    I think the big challenge potential employees of a startup face is not so much understanding the rules of vesting, but that they have no good framework for valuing their options. How can they, in an educated way, put a potential value on the company?

    1. fredwilson

      same way as we do Harryguess, hope, and pray 🙂

  18. Vivek Sagi

    Good post. I’ve been on both sides of the fence when receiving options as an employee and handing them out as a co-founder. What is a fair view of what % of total stock critical roles like a CTO, COO, V.P Marketing etc. should be given?

    1. fredwilson

      i will address this topic today

  19. Justin McGarry

    My company was acquired last year and all of my options vested immediately. Is this typically not the case?

    1. fredwilson

      you had single trigger vesting and that is not usual or normal

  20. ryanmeinzer

    Thanks Fred, this is extremely helpful!Could you please re-word and/or elaborate on, “That way no employee is more than half vested on their entire equity position.”?I am finding difficulty finding clarity in the vesting structure of your preferred four year vest with a retention grant after two years of service. For argument, lets say stocks are used. Does this mean that after two years the employee receives their first issuance of stocks with a retention grant for the remaining two years, of which the remainder of the stocks will be issued on an even quarterly roll-out schedule? Wouldn’t the employee be more than half vested by EOY 3 and fully vested on their entire equity position at EOY 4 then? This is why I am not clear on, “That way no employee is more than half vested on their entire equity position.”Aso, do you prefer stock or options in vesting schemes?Ryan Meinzer | Founder & CEO | PlaySay.com– Language Learning On The Go —

    1. fredwilson

      the first grant happens when the employee starts. two years later they are half vested on the four year vest. that’s when you make the retention grant

      1. ryanmeinzer

        Thanks Fred!