If you are a CEO of a startup planning to grant stock options or an employee who received option contract to sign, you must have heard of the term ‘vesting’. It seems complicated, but by the end of this post, you’ll get the point of it and be able to make use of it in your situation. (In case you want to be clear about what ESO (employee stock option) is before reading further, check out our last post here)
🙋What is Vesting?
Vesting is a process through which employees earn their shares of an asset. Since one of the objectives of employee stock options is to retain human resources, options can’t be exercised right away upon the conclusion of contract. The number of options available for exercise increases over time and on a schedule, a so-called Vesting Schedule. Another related term to this topic is the Vesting Commencement Date, which is a starting point where options begin to vest from. Vesting Commencement Date is usually the same as the Grant Date (a date the board approved the stock option grant), but another specific date could be selected by the Committee.
🗓️Types of Vesting Schedule
There are 3 types of vesting schedules, time-based, milestone, and hybrid.
Employees earn their stock options over time on a set schedule.
In general, there is a cliff, the time period before the employee can receive the first portion of the promised stock. The remaining amounts are vested over time.
For example, suppose you have been granted the right to buy 100 shares, and the options will be vested over 4 years with 1-year cliff. You get 0% vesting for the first 12 months, 25% vesting at the 12th month, and 1/48th (2.08%) more vesting each month until the 48th month.
- For the 1st year from the grant date ➡️ 0 shares vested
- At the end of the 1st year ➡️ 25 shares vested (1/4)
- At the end of the 2nd year ➡️ 50 shares vested (2/4)
- At the end of the 3rd year ➡️ 75 shares vested (3/4)
- At the end of the 4th year ➡️ 100 shares vested (4/4, fully vested)
So the cliff period is basically a time for patience. The time counts, but there aren’t any visible gains during that period. Planting an apple tree would be a nice metaphor. If you leave before the sprout comes out, you won’t get any fruits or even timbers at least. If you leave the company before the cliff period ends, you won’t get any stock options since the number of shares vested is zero.
Employees earn their stock options when they complete specific tasks or hit objectives set by the employer.
For example, a salesperson who sold the target number of units gains the stock options.
For an additional example, an accountant who completed a specific number of audits gains the stock options.
Employees earn their stock options after staying for a specific period AND reaching a specific milestone.
As expected from the name, it is a combination of time-based vesting and milestone vesting.
🙋How can I better keep track of vesting schedule?
Now you know what vesting is and how it works, but you might be still wondering how to keep track of it in your real life. Often understanding is one thing, and implementing it is another. Employers find it inconvenient to manage different vesting schedules with spreadsheet. This badly affects the objectives of ESO, keeping employees motivated and retaining top talents. And since all the vesting process is abstract compared to cash compensation in hand, employees are inevitably less motivated than expected. This is where QuotaBook comes in. At QuotaBook, employers can easily manage vesting schedule and employees can check their vesting status whenever they want with digital documents. Let’s schedule a demo to discuss your needs and show you how we solve them.
※ Legal disclaimer
Make Equity Complete — QuotaBook is a global equity management platform with a mission to create an ecosystem for private companies and their investors and employees. Leaving spreadsheets and manual works behind, every stakeholder can connect online and sync crucial data on equity such as cap table or employee stock options. It is the leading platform used by top startups and VCs in Asia, backed by Y Combinator.
This piece is written for information purposes only and is not intended as financial or legal advice. QuotaBook does not assume any reliability for dependence on the information provided above.