If you’re not familiar with vesting, the idea is that when a firm is launched, instead of issuing stock outright to the founders, the stock is distributed over a period of time, typically three to four years, as the founder or founders “earn” the stock. The same goes for employees who join the firm later and receive company stock. Instead of giving someone stock all at once, the stock is distributed over a period of time.

The reason vesting is a smart move is that although everyone is normally healthy and on the same page when launching an entrepreneurial venture, you never know what might happen. You want everyone involved with the firm to stay engaged. You also want a way of determining the price of a departing employees’ stock, if the firm has a “buy-back” clause in its corporate bylaws and wants to repurchase a departing employee’s shares. Vesting provides a mechanism for accomplishing both of these objectives. A typical start-up’s vesting schedule lasts 36 to 48 months and includes a 12-month cliff. The cliff represents the period of time that the person must work for the company in order to leave with any ownership interest. Thus, if a company has a 48-month vesting schedule and offers 1,000 shares of stock to an employee, if the employee leaves after 10 months, the employee keeps no equity. If the employee leaves after 28 months, the employee gets to keep 28/48 of the equity promised, or 583 of the 1,000 shares. The shares will be issued at a specific price. If an employee leaves and the company is entitled to buy back the employee’s shares, normally the buy-back clause will stipulate that the shares can be repurchased at the price at which they were issued.

Vesting avoids three problems. First, it helps keep employees motivated and engaged. If the employee in the example mentioned in the previous paragraph received his or her entire allotment of 1,000 shares on day one, the employee could walk away from the firm at any point and keep all the shares. Second, if an employee’s departure is acrimonious, there isn’t any squabbling about how many shares the employee gets to leave with—the answer to this question is spelled out in the vesting schedule. In addition, if a buy-back clause is in place and it stipulates the formula for determining the value of the departing employee’s stock, the company can repurchase the shares without an argument. It’s never a good thing to have a former employee, particularly one that left under less than ideal conditions, remain a partial owner of the firm. Finally, investors are generally reluctant to invest in a firm if a block of stock is owned by a former employee. It just spells trouble, which investors are eager to avoid.

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Summary:

Vesting ownership in company stock is a smart strategy for startups. It helps keep employees motivated and engaged, and it provides a way to determine the price of a departing employee's stock.

A typical vesting schedule lasts 36 to 48 months and includes a 12-month cliff. This means that employees must work for the company for at least 12 months before they vest any of their stock. After that, they vest a certain percentage of their stock each month or quarter.

Vesting avoids three problems:

1. It keeps employees motivated and engaged. If employees know that they will lose their stock if they leave the company early, they are more likely to stay and work hard.

2. It provides a clear way to determine the price of a departing employee's stock. If the company has a buy-back clause, it can repurchase the stock at the price at which it was issued.

3. It prevents former employees from owning a block of stock in the company. This is important because investors are generally reluctant to invest in a company if a significant portion of the stock is owned by former employees.

Overall, vesting ownership in company stock is a smart strategy for startups. It helps keep employees engaged, provides a clear way to determine the price of departing employees' stock, and prevents former employees from owning a significant portion of the company.