Startups · Entrepreneurship

Is 4 year vesting really fair?

Richard Tan Internet Marketer, Social Media Manager, and Freelance Writer

September 9th, 2016

I hear nowadays that to reward an employee the norm is to give out equity in the form of stock options with a 1 year cliff and 4 years vesting. Is this fair and reasonable?


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Scott Harrison Founder at Quinch

September 11th, 2016

The traditional 4/1 vesting profile is absolutely reasonable and in no way inherently unfair.

Mike's point that "The way to divide the equity has nothing to do with how long you thought people were going to play" is correct. The problem is that how you allocate equity has nothing to do with whether you use a vesting process. On a side note, walking into an VC's office with a company cap table that has a nonstandard incentive program is likely to create a real problem for that investor.



Steve Savad CEO, President, Senior VP: Marketing, Bus Dev, Sales

September 9th, 2016

I am a firm believer that everyone should be created and treated equally. If any member of the founding team is given a vesting schedule, then everyone should have the SAME schedule.Offering different schedules to different founders is just wrong. Or, if one founder has no vesting window, then give everyone no vesting window. 

Syed Hosain Founder, SVP Engineering and CTO at Aeris Communications, Inc.

September 10th, 2016

This isn't a new thing - it has been around for decades in Silicon valley for example! At the companies I have been at, the approach was:

1. Nothing till the end of the first year. Then immediately vested 25% of the total.

2. Every month after that, vest 1/48th of the total ... so that the total period was 4 years.

Nothing unusual in this, and it is completely fair, as far as I am concerned. The first year is essentially a trial year, till the employee proves themselves as having been a good and correct hire.

Also, in some of the companies I have been at, we received additional grants *later* - not every year, of course, but every 2 to 3 years. If they were *after* the first year of employment, the additional shares began vesting immediately at a 1/48th rate for those shares right from the date of the grant.

Chuck Bartok Marketing and Sales Manager at MD Building Systems of Florida, Inc

September 9th, 2016

Interesting how the generations of cupcakes and entitlement employee mindset seem to think they deserve such thing as "benefits".

If one does not like the set up don't accept the Job and find that Utopian Company elsewhere.




Greg Buechler Sr Talent Acquisition: 925-487-9739

September 10th, 2016

The four-year model (1 year cliff for 25% of initial options +monthly thereafter) is a time-tested model. It is how Silicon Valley was built. Many organizations continue to add additional option grants each year through their performance review process. Hence many employees always have options that are four years out: hence the term golden handcuffs. This model puts great value on both value growth of the organization and continued contribution by the employee. It also provides a stable, projectable value of those options from an accounting basis. Always follow the money trail - clarity is found there.

The fairness questions can only be answered by making sure that equal performance is rewarded equally with no variance based on who is liked, who knows who, or by gender, race, etc. 

The equity mix between founders and future employees is a different dialog. Ultimately it is an idea-investment-risk-reward equation. Founders have the idea, they invest their own time, capital, and in many cases risk their personal fortunes. Very early employees also take on greater risk than those that are #50, 100, 500, etc., so they to get greater numbers of shares, lower strike prices, etc.  It would be entirely unfair that employee #5,000 at Facebook receives the same stock options grant as employee #50.  #5,000 knows their paycheck is good, that the benefits are crazy good, that they get to use company busses, cafeterias, the list goes on.  #50? I am pretty sure they had more than a few sleepless nights wondering if they had a job in the morning. 

Jacob Kojfman Experienced technology and corporate lawyer, focusing on SAAS

September 9th, 2016

Yes, very much so. Think about it - you want to give options to people who stick around for just the 1 year, as soon as the cliff period is over, they all leave with all of their options?

Mike Moyer

September 9th, 2016

Time-based vesting is NOT FAIR.

Yes, everybody does it, yes, it's the "norm," and yes, most people will tell you to do it and yes, it may sound logical.

But...

Vesting is a Band-Aid on a bigger problem: the underlying equity split is never, ever fair. So, vesting is a weak attempt to protect yourself from the inevitable problems caused by a bad underlying split.

It works a little, but by no  means is it fair.

With time-based vesting what happens if I get fired the day before I vest? I lose. Or what if I quit the day after? The company loses. 

Vesting is just a thing that most people think you should do. It's just part of the conventional wisdom which unfortunately, is flawed.

Traditional equity splits with a time-based vesting schedule is the norm, just like thinking the world was flat was the norm at one time.

Then people realized that the world was round and this opened up a whole new way of looking at things.

The "world is round" approach to equity is the understanding that equity should be dynamic and should be based on what people contribute.

Think of your startup as a casino game. You and your partners contribute time, money, ideas, relationships, etc. Each of these contributions is a "bet" on the future outcome of the game. Winning the game means you generate profits or you sell the company.

The way to divide the equity has nothing to do with how long you thought people were going to play. It has everything to do with the bets placed. Your share should be your bets divided by all bets. If you placed 40% of the bets, you should get 40% of the winnings. 

This should be obvious.

Vesting means that you try to figure out how to divide the winnings up before you start playing and that you try to figure out how long its going to take to win and you put vesting in to keep people at the table, even if they want to leave.

That's weird and unfair.

Wait until you win, then count the bets.

This is called the Slicing Pie model and you may have a copy of the Slicing Pie book if you contact me.

Scott McGregor Advisor, co-founder, consultant and part time executive to Tech Start-ups. Based in Silicon Valley.

September 10th, 2016

This was the offer I received in early 1990 when I joined my first Silicon Valley VC funded start-up. It has also been what I have been offered for every other SV VC funded start-up I have worked for in the 26 years since. I have seen some companies with slightly shorter cliffs (e.g. half year or 90 days), and some with slightly shorter vesting periods (36 months) but these were rare exceptions to the general rule. “Fair and reasonable” is a value judgement that different people might make in different ways. “Workable” is probably a better criteria, and the survival of this model for more than 25 years is strong evidence that it is probably workable in many cases.

Tahir Naim Executive Compensation and Benefits Attorney

September 11th, 2016

4/1 has been the SV norm since before the dotcom bubble. Previously, it was 5yrs when California securities law set that as a minimum. 4/1 is the easy way when "fair" is not easy to determine. To know what is "fair" in a particular situation you have to have a clear idea of what you are compensating and when that is "earned".  I can give you a legally enforceable document, but one of those founder dilemmas is setting numbers and vesting schedule. Don't abdicate. Decide and then evaluate and reiterate.

Scott Harrison Founder at Quinch

September 12th, 2016

Hey Mike,


I can understand what you are trying to achieve but I'm not sure that it doesn't raise just as many questions.


Example one: I don't really understand this point at all. The value of the equity is certainly questionable at the early stage of a company, but investment valuations provide some level of benchmark beyond profits. If those valuations are good enough for parties committing money, they should serve as a good measure of equity value.


Example two:It would be extremely unusual to have an accelerated vesting provision in a incentive program. During a buyout or new round, it's true that the company could accelerate vesting in a way that is unfair to some employees but typically it's handled in a way to both reward employees and incentivize staying with the company. Full acceleration of an employee's equity creates a risk to the company. It should be noted that unvested or unallocated shares at the time of a purchase would fold back into the company and as such distributing it indiscriminately would be unfair to shareholders as well as employees.


Example three: True, but I've never seem anything that didn't incentivize employees to stay with the company.


Example four: I don't see the connection between vesting and dilution. A company's employee incentive program will represent a percentage of equity and allocating shares willy-nilly or not has no dilutive impact. That said, during a new round investors could push to reduce the size of the incentive program thus diluting employees. But once again, that's a issue of equity allocation not the vesting model.


Example five: That's true. Employers could terminate employees the first year without cause and employees could leave just after initial vesting. To model an incentive program you have to assume that the goal of both parties is to have a successful relationship. Equity is not compensation and shouldn't be treated like it is. Not every employee that walks in the door should be elevated to the status of shareholder. That would create a huge drag that would prevent the company from rewarding those that contribute. A vesting system allows employees time to prove their value to the company. It's called an incentive program for a reason. You earn equity by contribution, you receive equity by commitment.


Example six: There is rarely a cliff in an employee's vesting. You're continually awarding more equity to valuable and contributing employees and that follow on equity starts vesting immediately. We also have to realize that lives change and people move on for reasons that aren't connected to the company. The vesting model allows employees to make decisions about their future with the company.


As for the split at the outset, I agree that there might be better ways to structure the initial common stock distribution but that problem is separate from the employee incentive programs. It sounds to me like we're combining two issues that are tangentially related.

It's good topic and a discussion on how to fairly award equity or measure contribution would be a great followup.

I'm always up for reading something new.


Scott