Vesting 101: what is vesting and why is it important to startups?

Olivia Chuang

Published in

Ataeum Blog

6 min readAug 1, 2021

The ultimate guide to vesting for startups

What it is, examples of vesting in practice, and its pros and cons

One of the most fundamental principles of startup operations is a process called vesting — a legal process of earning rights to a present or future payment, asset, or benefit (more on this later!). When executed well, a vesting scheme can shape a team’s loyalty and commitment to the success of the business while also reducing cash used in the company’s operating expenses.

Introduction to startup equity

If you are like the other hundreds of thousands of individuals bootstrapping your startup, it’s likely that your founding members will not be compensated in cash in the near future. Instead, compensation in the early stages of your startup will be largely distributed using equity.

Definition: Equity | The value of the shares issued by a company.

While some may be satisfied with deciding the equity split among co-founders with a simple handshake, statistics show that co-founder disagreements are one of the greatest startup killers. Former Harvard Business School Professor, Noam Wasserman’s research suggests more than 65% of startup failures are due to co-founder issues. Think Mark Zuckerberg vs the Winklevoss twins vs. Eduardo Saverin. AKA, you probably should rethink banking the future success of your company on a spoken agreement.

Equity and the way it is split among team members is very important as it is what gives each founder the right to vote, the right to receive dividends, and ownership over the company.

Not to worry. There are several clear steps you can take to ensure you start on the right foot.

Though perhaps somewhat awkward and formal, especially when you are founding with friends or family, having a conversation about the roles, expected contributions, and equity split among each of your founding members is an extremely critical part of setting your startup up for success. And if you’re having a conversation about equity split, you should also be having a conversation about how each of your shares will be vested.

So, what is vesting?

Whether you’re a seasoned entrepreneur or are just entering the startup world, chances are you’ve heard the word “vesting” thrown around. But what exactly is vesting and what does it mean for startups?

Put simply, vesting is a term that is used to describe the legal process of obtaining rights to a present or future payment, asset, or benefit. Through this “vesting period” or “schedule”, you are accruing or acquiring a legal right to shares that cannot be taken away by any other parties.

In the context of startups and companies, vesting is important because it is also the tool by which a company also has the right to forfeit and buy back unvested shares from founders who walk away before the end of their vesting schedule or if they are not contributing to the company as agreed upon. This ensures the long-term commitment of founding members.

Okay, woah there. We just touched on a bunch of new vocabulary. Let’s simply breakdown some of the important terms that come into play when discussing vesting:

Definition | Vesting Schedule/Scheme: The timeline on which the shares are “vested”. A standard vesting schedule is usually across 4 years meaning that all shares will be vested at the end of 4 years.

Definition | Unvested Shares: Unvested shares are the portions of equity that have yet to be realized with the passing of time and completion of a person’s role.

Definition | Cliff date: A cliff date is the designated date on which a person’s shares will begin to vest. For example, let’s say the contract specifies a one-year cliff. This means that if any of the parties in the contract walk out of the startup before the one-year cliff date, they won’t receive any of the equity they own.

Definition | Immediate vesting: As you may suspect, this type of vesting schedule provides 100% ownership of shares at the time of signing the contract, aka there is no cliff in this vesting scheme. Immediate vesting is a relatively uncommon vesting schedule.

Definition | Graded vesting: A graded vesting schedule means that ownership is provided over a determined period of time through equal portions. This is the most common type of vesting schedule. In this schedule, a person will only receive the shares that have been vested at the time that they walk out of the company.

Vesting in practice

Let’s see what a standard vesting schedule might look like in practice.

In this startup, there are two founders — Founder A and Founder B — who both own 50% of the company. The startup is on a four-year vesting schedule with a one-year cliff. If Founder A was to walk away before the one-year cliff date, Founder A would not receive any of the 50% equity they owned. If Founder A left after two years, they will have vested half of their equity (25% of the company) which Founder A can walk away with or sell back to Founder B for a reasonable price. Founder A’s remaining unvested shares (25% of the company) will be forfeited and returned back to the company. If Founder A leaves after four years, they will have vested all of their shares (50% of the company).

Why does vesting matter and why should all startups utilize this tool?

Vesting can be used as a motivational tool for founders to make long-term commitments to the company and the mission
The longer they work with the business and contribute to its success, the more they stand to gain.
Unlike employees on a payroll, employees paid through equity can reap the benefits of the business’s success through the shares they own
Vesting protects against departing leadership members
If a founder or leader leaves early on or isn’t contributing as agreed upon to the company, they’ll be compensated (or not compensated) accordingly.
Professional investors prefer vesting which is good for raising capital at later stages of your startup

How do you set up a formal vesting schedule?

At this stage, you might be wondering how do you formally create and execute a vesting schedule?

There are generally three different types of vesting

Founders agreement (vesting in the agreement among founding partners of a company)
Employee vesting (vesting carried out through stock options to encourage employees and managers to become part of a startup’s success and journey)
Advisor vesting (vesting often carried out on a shorter vesting schedule to provide compensation to advisors and mentors for contributing their experience and knowledge in strategy for the startup).

One of the simplest ways to carry out your vesting scheme is as an Ataeum Venture.

Once you upgrade your project to a venture on this platform, one of the features you will have access to is the smart vesting tool. This feature allows you to automatically vest shares according to an agreed-upon schedule and cliff on the condition that founders and employees are actively contributing to the startup.

What happens with your vesting scheme if your startup is acquired?

In the event that there’s a change of control — for example, the company is acquired — an “acceleration” is a special feature that deals with the treatment of the outstanding unvested shares. There are two possible outcomes that can happen in these circumstances:

Single Trigger Acceleration: In this case, all unvested shares of employees vest all at once irrespective of the timeline decided on in the previous vesting schedule. Founders can leave immediately with 100% of vested shares.

Main characteristics:

Founders are not required to stay at the new company
All shares auto vested irrespective of original vesting schedule
Can cash out of the equity you built

Double Trigger Acceleration: This type of acceleration happens when the company is sold or acquired and the founder(s) are terminated without cause. Double Trigger Acceleration ensures that the founders’ position is protected in the new company and that all others involved in the startup will be brought onto the new company. In this case, you are not able to cash out your equity unless terminated with the sale of the company.

Main characteristics

Founders and early employee positions protected within the acquisition and move to the new company
Not able to cash out your equity unless terminated with the sale

Now that you’ve read through this guide, you have a better sense of what vesting is and its significance in the startup environment. If you have any questions about smart vesting on Ataeum, feel free to reach out to us at help@ataeum.com.