What is vesting?
Vesting is a contractual mechanism by which a person earns the right to keep the equity they hold in a company. Vesting is usually time-based over a specific period of time (e.g., four years) or after specific milestones are hit (e.g., the company hitting a certain valuation).
Why vesting matters?
Until equity is earned or “vested,” the company retains the right to reclaim or terminate it. Employees of a company usually vest their equity by remaining employed by the company over time. Vesting is also commonly applied to equity held by consultants and advisers.
Why is vesting implemented?
Implementing vesting on equity held by service providers, such as employees, helps to incentivize them to stay and build the company. If a service provider leaves, their unvested equity can be reclaimed by the company. This reclaimed equity can then be reissued to new service providers or held by the company for use in the future.
In addition, investors expect, and in many cases will require, that vesting is implemented on equity held by service providers. To illustrate, if someone owns 25% of a company in stock with no vesting, then that person could walk away at any time with all of those shares without having to do any more work to build the value of those shares. This would be unfair to the people who remain and to new hires. If the person’s stock were instead subject to vesting, then if that person left the company, they would be able to keep only the shares they had earned through their work during the vesting period.
What is a standard vesting schedule?
For employees of startups, a standard vesting schedule for equity awards (such as stock or stock options) is four years with a so-called one-year cliff. The cliff refers to the minimum period of time the employee needs to work to earn any of the shares.
One year cliff vesting
With a one-year cliff, no stock vests until the employee’s first anniversary with the company, at which point a pre-determined percentage (usually 25%) of the stock vests all at once. Following the one-year cliff, the remaining stock will then vest in equal monthly increments for the next 36 months. If the employee leaves the company after having worked for only 11 months, the employee will not have the right to retain any stock, as the employee has not yet hit the one-year cliff. If the employee leaves after working at the company for two years (24 months), the employee will keep 50% of the stock (two years worked out of the four-year vesting period).
Startup advisor equity vesting: The no-cliff schedule
For advisers, a typical vesting schedule is one or two years with no cliff. This means that the stock vests in equal monthly increments over 12 or 24 months. With a 24-month vesting schedule, if the adviser ceases to provide services to the company after 11 months, the adviser would keep 11/24ths of the stock.
What is accelerated vesting?
When certain conditions are met, vesting can be expedited from the standard timeline that an equity grant would otherwise vest. This is called vesting acceleration.
Who should accelerate vesting?
While accelerated vesting benefits the equity holder, companies should take care when including acceleration in equity grants. Factors such as the type and quantity of vesting acceleration provisions may alarm investors or potential buyers.
Defining your company's philosophy around vesting acceleration starts with understanding the varieties of acceleration and the market trends surrounding each.
What is single-trigger acceleration?
Single-trigger acceleration typically provides partial to full vesting acceleration upon a change of control event, such as an acquisition. The "trigger" is the change of control.
Single-trigger acceleration is uncommon, except for advisers. Most companies generally do not award equity with single-trigger acceleration, but when they do, it is typically to advisers who negotiate for it.
Companies tend to be more comfortable with single-trigger acceleration for advisers because a typical adviser grant is relatively small. Advisers often provide services early in the company’s lifecycle, when an acquisition is unlikely during the vesting period, making this an often inconsequential term.
What is double-trigger acceleration?
Double-trigger acceleration usually provides from partial to full acceleration of vesting upon termination within 12 months after a change of control event. Both the change of control trigger and the second, termination trigger must occur for the vesting to accelerate.
Double-trigger provisions protect key personnel from the company being acquired. Double-trigger acceleration is fairly common among founders and executive hires. The provisions ensure that their stock will immediately vest if they are not kept on by the buyer, so long as they aren’t terminated for cause.
How common is double-trigger acceleration?
While double-trigger acceleration is commonly employed to protect founders, offering it to all employees is even less common. If every employee had the double-trigger acceleration option, a potential buyer would only make personnel changes with a prohibitive number of shares being granted to departing employees via acceleration provisions.
While each company should develop its own compensation philosophy, founders should design compensation with care because it can become strategically important down the line.
Single vs. double-trigger acceleration
Single-trigger and double-trigger acceleration are two types of vesting acceleration in employee equity agreements.
Single-trigger acceleration means that upon the occurrence of a specific event, typically a change of control or acquisition of the company, a portion or all of the unvested equity awards become immediately vested.
On the other hand, double-trigger acceleration requires the occurrence of two events for the equity to vest. Typically, these two events are a change of control or acquisition, followed by the termination of the employee's employment without cause or for a good reason.
In essence, single-trigger acceleration accelerates vesting based on a single event, while double-trigger acceleration requires two events to occur before vesting is accelerated.
The differences between single-trigger acceleration and double-trigger acceleration in terms of definition, examples, and purposes are summarized in the image below.
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Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.