Vesting stock is a mechanism for individuals to earn their ownership in a company over time. Typically, vesting occurs according to a set schedule or upon completion of a significant task. In most cases, full vesting occurs when a startup’s right to repurchase lapses. This means that the longer someone works for a company, the more shares they will own that the company cannot repurchase.
Is there a vesting standard?
Currently, the vesting standard for tech companies is a four-year vesting period with a one-year cliff period, and monthly vesting percentages after the cliff period. This means that an individual will not own 100% of their shares for four years and if he is terminated within the first twelve months, he will leave with no shares. However, the time period or milestones that trigger vesting is up to the company to decide.
Why is vesting important?
(1) Vesting protects against free-riders
Vesting ensures that founders must stay involved in growing the business to earn their shares. Someone who leaves the business shortly after it begins should not be able to sit back and profit from a large chunk of stock while the remaining folks put in substantial effort over several years to grow a successful business. To earn the right to participate in the future rewards of the business the recipients of stock, including the founders, should have to continue working for the company for a designated period of time.
(2) Investors expect vesting stock
Investors invest in people just as much as they do ideas and technology. In fact, it is usually the team that is the most important factor in early stage investments. So, most investors require vesting to keep the team around and motivated.
How do I give away vesting stock?
Anyone who receives stock subject to vesting in your company should receive and sign a Restricted Stock Agreement. This agreement outlines: percentage, type of stock, vesting schedule, right to repurchase, enforceability, and any other terms you require.
Anytime vesting is imposed on restricted stock, the recipient should consider filing a 83(b) election with the IRS.