Stock Vesting For Startups – The 2024 Guide

Startups rely on their employees. Without a good team, you’ll struggle to bring your vision to life. Stock vesting is one of the best ways to reward your hardworking staff. Over time, they will be able to earn equity in the business. As the value of the company rises, so does the value of their stock. Let’s take a closer look at how your startup can motivate your employees through stock vesting.

Types Of Stock Vesting

Though it sounds complex, this process is quite simple. The first thing you need to do is decide which type of stock option you want to use. There are a few approaches available:

• Time-based shares. This is designed to keep employees around for a set period. It helps to look at an example. Perhaps your business wants to keep an employee for four years. You allocate them 100 shares. Each year, they get 25 shares. If they leave early, they’ll only get a portion of the stock. 
• Milestone-based shares. The next option is to set out clear milestones. The stock gets vested when these milestones are achieved. 
• Hybrid shares. These are a combination of both time-based and milestone-based approaches. Usually, the employees will get shares over time. But they will also get rewarded for hitting performance-based milestones. 
• Reverse vesting. This is commonly used for high-ranking executives. They get all their stock upfront. But there are strings attached. The company can take the stock back if they don’t meet their milestones. 

Once you know what type of plan you want, you can assign your employees options. These give them the right to vest stock. But they won’t be able to exercise their shares until they have fulfilled their obligations. Until they get transferred from option to stock vested, the shares are worthless. 

Important Vesting Terms

Now that we know the basics of stock vesting, let’s get down to the nitty-gritty. In particular, here are some of the critical terms that you should know:

• Bad leaver. This refers to people who leave your company under bad circumstances. They could be fired because of misconduct or have broken their contract. Usually, there is a provision in their stock vesting agreement that renders their stock options void. 
• Liquidity event. Sometimes, your stock vesting schedule needs to be brought forward. A common example is when the company is listed on the share market. Or you might have been taken over by another business. Events like this will cause shares to be issued immediately, rather than according to the vesting schedule. 
• Incentive Stock Options (ISO)/Non-Qualified Stock Options (NSO). These refer to the way the stocks are given to employees. ISOs have lower taxes. But NSOs offer more flexibility. It’s best to consult with your accountant, to find the approach that is best for your company.
• Cliff. This is the time when the shares will start vesting. Most of the time, startups will use a one-year cliff. If the employee leaves within that year, they don’t get any shares. Once the cliff period is over, they start earning shares according to the stock vesting schedule. The cliff period begins on the day that an employee signs their contract and joins the company. 

Setting Up Stock Vesting

Many startup founders like the idea of stock vesting. But they worry that it’s too hard to set up. After all, they only have a limited amount of time and resources. Thankfully, there is an easy way to solve this problem. You can write the contract yourself. 

There’s no need to worry about complex legal language. Plenty of companies offer a standard template. This can be personalized to suit your business. All you need to do is get your lawyer to review these contracts. Taking this approach can save you thousands in legal fees. 

Other Important Stock Vesting Details

You should keep a few other things in mind when implementing stock vesting in your startup, these include:

• Stock vesting time. The ideal stock vesting period varies from startup to startup. Most of the time, people select one to five years. Longer than five years and the promise of stock might not be enough to convince an employee to stick around. 
• Amount of stock to give away. Again, this will vary. Though there is no hard and fast rule, most companies opt to give 1% to the earliest members. The equity you give away will shrink as the team expands. This rewards employees who were with you from the start. Generally, investors get a 40% stake. 
• Amount of stock to keep for founders. It’s not a good idea to give away too much equity. If you do this, there’s a chance you could lose control of the company. Because of this, founders often keep 60% of the stock. 

Conclusion

Stock vesting is one of the best ways to reward your employees for their hard work. The longer they commit to the company, the more shares they’ll earn. Even better, it’s easy to establish this program within your startup.