Employee Stock Options: Definitions and Key Concepts

 


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What is founder vesting?


A vesting schedule for founders is a reasonable request from any shareholder investor and employee alike and frequently in the best interest of the founders for several reasons:. The real message above is that you want to maximize the value of your equity, not maximize your equity. I can understand why some entrepreneurs mistrust investors and why they believe that vesting schedules serve more nefarious purposes. You would receive one fourth of your options after your first year at the company.

Thereafter, vesting would continue at a monthly or quarterly rate until you own the full amount at the end of the fourth year. Opinions seem to vary on annual vs. I believe that an employee or founder waiting for a vesting event to occur before leaving is detrimental and more costly to the company, therefore cliffs should be kept to a minimum.

Many option agreements contain vesting acceleration clauses. Triggers either reward employees for an acquisition, or protect them in the event of an acquisition. I am about to interview for a position with a start-up that offers a profit sharing plan. I have never worked for a start-up and am not familiar with options as part of the compensation.

What happens if your contract has double-trigger acceleration, but you are terminated BEFORE change of control acquisition? You should speak with a lawyer. I can imagine that you might have a claim depending on how the events might be linked, but I really don't know.

My option grant does not have an acceleration clause in it that account for when the company changes hands. What are the draw backs here? To make the reward commensurate with the extent of contribution, encourage loyalty, and avoid spreading ownership widely among former participants, these grants are usually subject to vesting arrangements. Vesting of options is straightforward. The grantee receives an option to purchase a block of common stock, typically on commencement of employment, which vests over time.

The option may be exercised at any time but only with respect to the vested portion. The entire option is lost if not exercised within a short period after the end of the employer relationship.

The vesting operates simply by changing the status of the option over time from fully unexercisable to fully exercisable according to the vesting schedule. Common stock grants are similar in function but the mechanism is different. An employee, typically a company founder, purchases stock in the company at nominal price shortly after the company is formed.

The company retains a repurchase right to buy the stock back at the same price should the employee leave. The repurchase right diminishes over time so that the company eventually has no right to repurchase the stock in other words, the stock becomes fully vested. Beginning in the s, vesting periods in the United States are usually 3—5 years for employees, but shorter for board members and others whose expected tenure at a company is shorter.

The vesting schedule is most often a pro-rata monthly vesting over the period with a six or twelve month cliff. Alternative vesting models are becoming more popular including milestone-based vesting and dynamic equity vesting. In the case of both stock and options, large initial grants that vest over time are more common than periodic smaller grants because they are easier to account for and administer, they establish the arrangement up-front and are thus more predictable, and subject to some complexities and limitations the value of the grants and holding period requirements for tax purposes are set upon the initial grant date, giving a considerable tax advantage to the employee.

Profit-sharing plans are usually vested in ten years, although in some cases a plan may serve essentially as a pension by allowing a limited amount of vesting should the employee retire or leave on good terms after an extended period of employment. The vested rights doctrine is the rule of zoning law by which an owner or developer is entitled to proceed in accordance with the prior zoning provision where there has been a substantial change of position, expenditures, or incurrence of obligations made in good faith by an innocent party under a building permit or in reliance upon the probability of its issuance.

A "vesting period" is a period of time an investor or other person holding a right to something must wait until they are capable of fully exercising their rights and until those rights may not be taken away.

In many cases vesting does not occur all at once. Specific portions of the rights grant vest on different dates over the duration of the period of the vesting. But in many instances, the vesting schemes have a favorable tax outcome. As mentioned earlier, there are different ways a startup can organize its vesting scheme. When you are selecting a vesting scheme model, you should cover the following points. The best model for your startup can depend on the type of business you are running, as well as the number of people involved, for instance.

You should always consider the benefits and disadvantages of each scheme for your business. While certain common models might work well for other startups, your business might benefit from a more unconventional model. Your startup likely has people such as the founders, employees and board members working for it.

In order to provide incentives for all of them, you can use different vesting models for each group. Startups must decide whom they offer the vesting schemes and they must pick the vesting schedule for each scheme.

A vesting schedule dictates the timeline for exercising the stock options, in addition to the restrictions on the stock. The schedule is time-based and as mentioned above, often uses a monthly schedule over four years. The schedule is important part of setting up the scheme, as it can help ensure the company has enough protection. In addition, it also defines the attractiveness of the scheme.

If the vesting schedule is too long, employees might not be incentives to sign to it. On the other hand, if the schedule is too short, the startup might not benefit in terms of protection. When the business is picking the vesting schedule, incentivizing is a key part of the equation, together with protecting the company. Finding the right schedule is also crucial in terms of business finances. If the vesting schedule is too rapid, the company might find it difficult to support it financially.

If the company loses a large chunk of the ownership at once and has to provide most of the profits to shareholders, it can hit its ability to finance growth. Therefore, a startup with a number of vesting schemes has to carefully devise the timeline to ensure it can financially afford it. Finally, the vesting schedule can accelerate upon a specific instance. The instance that typically involves acceleration involves company acquisition.

There are essentially two different accelerating scenarios in this case:. While the above shows how there are a number of ways to set up a vesting scheme, startups tend to go with a so-called standard vesting schedule.

The standard model has been found by many to be a viable option, but it is by any means a model you should automatically subscribe to. In both of these instances, the company would also have to decide whether or not to use accelerating schedule. As mentioned earlier, acceleration is often used in the case of founders, but skipped with employees.

Vesting can be a crucial tool to manage business finances and reward the people who help ensure the startup succeeds. Setting up a vesting scheme should be considered and carefully planned to maximize its benefits. For many startups the most important questions to answer involve the groups of people, they want to include to the vesting scheme and the timeline for vesting.