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. 4 years), or after specific milestones are hit (e.g. the company hits 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 vesting is 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 both 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.
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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.