Primer on Vesting Schedules
Vesting Schedules are most often engaged in the context of Founder Vesting or Stock Options.
In short, a vesting schedule refers to the “earning” schedule of equity in a company. Typically, when founders, employees, advisors and consultants are granted equity (in the form of shares, options, phantom shares, or some other mechanism), that equity is being given as “sweat equity”, where the payment of that equity is not monetary but earned in with contributions to the business. It is there to incentivize contributions and also to protect the company if contributions are not made.
When it comes to creating a vesting schedule, there are a number of options available that you may consider using. These include:
· time-based vesting schedules;
· milestone-based vesting schedules; and
· mixed vesting schedules.
Time-Based Vesting Schedules
The standard vesting schedule for both Founder Vesting, Stock Options and other “sweat-equity” mechanisms, is time-based. This is, without a doubt, the simplest approach.
For founders and employees, the standard vesting schedule is: 4 year vesting with a 1 year cliff. This means that the equity vests over 4 years, with the first vesting event occurring 1 year after the start date. We’ve detailed this vesting schedule in our Founder Vesting article.
For advisors, the standard vesting schedule is: 2 year vesting in equal monthly increments starting immediately.
While these are the standard vesting schedules you see most often, you can customize these to meet your specific circumstances.
Time-based vesting is simple - if you remain engaged with the company throughout the term, you will earn the equity. If you are terminated or resign during the term, you will only earn up to that date of termination or resignation.
Generally speaking, time-based vesting is the safest approach. There is very little to negotiate, there is very little room for entitlement disputes between the parties, and it is easy to model your cap table.
Milestone-Based Vesting Schedules
Time isn’t always the best measure of performance or contribution though.
In some cases, time-based vesting can even incentivize less efficiency. For example, if you have hired a development team to build your product, and have incentivized them with equity on a time-based vesting schedule, it is in their interest to take more time to build, so that they earn more equity. The faster they are, the less equity they earn, even if the product they deliver is excellent.
As a result, it may be more appropriate to offer a milestone-based vesting schedule. This is when vesting is tied to the happening of certain events.
Examples of milestones could include:
MVP delivery with company’s written acceptance;
Company reaching $30k in monthly revenue;
100,000 downloads of the app; or
10 reseller partners signed.
With this type of vesting schedule, it is critically important to chose objective milestones that aren’t open to interpretation or dispute.
A commonly disputed milestone is one that says something along the lines of: “25% vested upon delivery of MVP ”. The problem with this is, the developer and the company may each have very different ideas of what an acceptable MVP includes, and therefore when the milestone is actually hit. The developer may be confident that they’ve done what is required to trigger vesting, but the company may feel that the MVP is incomplete, too buggy, inconsistent with specs provided, or missing key features. “Delivery of MVP” is subjectively determined - each party can have different opinions on whether that was done - and so it is not a helpful milestone.
Milestones should be objective, binary, and indisputable. Anyone should be able to say either yes or no as to whether the milestone has been hit, without any room for interpretation.
The examples in bullets above show this in action:
“MVP delivered with company’s written acceptance”- while an MVP may have been delivered, it is only considered a complete milestone after company provides written acceptance, which is very easy to determine.
“Company reaching $30k in monthly revenue” - including a specific number that relates to the financial statements makes it a simple, objective calculation. Compare this to a subjective milestone that says “strong revenue” - which would be unhelpful and ripe for dispute.
“100,000 downloads of the app” - including a specific number and tying it to a metric that is objective and simply the result of a data pull, ensures that there is no dispute about whether it’s been hit.
“10 reseller partners signed” - notice that this milestone requires that each reseller partner actually “sign” with the company. The partner either signed or didn’t. No room for dispute. No matter how far along the partner is in negotiations, or how confident you are that you’ll close them, they don’t count to the milestone until they sign.
Mixed Vesting Schedules
You can also combine time-based and milestone-based vesting schedules.
There are two ways that this could be done:
(1) Blended: Where vesting only occurs if the milestone happens within a certain time period. For example: 25% vests on delivery of the MVP with company’s written acceptance (milestone) provided that delivery and acceptance is provided no later than 12 months from the date of start (time).
This form helps to create more accountability by ensuring that the milestone is completed within a period of time that is actually helpful to the company.
(2) Separate: Where some vesting occurs by time and some by milestones. For example: 50% vests on a 4 year vesting schedule with a 1 year cliff (time) and 50% vests on reaching 500,000 downloads on the app store (milestone).
This form helps where the deliverables and responsibilities are not fully known yet or acknowledged to likely change in the term ahead.
Ink LLP is a business law firm that acts as strategic counsel to ambitious entrepreneurs, investors, and high-growth companies. Contact one of our lawyers to discuss your business and how our team might be able to help you tackle the challenges of your business and the opportunities for growth.
This information is provided for informational purposes only and is not legal advice.