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Vesting done right. What it is and how to use it.
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Vesting done right. What it is and how to use it.

17th June, 2014

Here at ChatGrape we’re all about teamwork and communication. A crucial aspect of this is getting across how your company’s success will reflect on your team members: Creating an environment where your employees and team members feel like they’re part of the company, thus creating a vested interest for everyone involved in the company’s success, will have a huge impact.

Startups, Equity, Advisors, Salaries.. what now? First off: What is this mysterious “vesting” that everyone seems to talk about?

You’re likely founder or otherwise part of a startup and you’re looking to hire key people to get involved into your product or company. However, you lack the funds to pay their market value and you’re looking for other ways of compensation. You might also want to give future employees equity to increase their commitment or use a little equity to get advisors on board. Furthermore and most importantly, you want to make sure that said people stick with your company over a certain minimum amount of time. In short: You want to give away equity of your company, but you don’t want to risk ending up with a shareholder who doesn’t contribute value in the long run. That’s where vesting comes in handy.

Example scenario with arbitrary numbers:

Employee X, a talented and experienced software engineer, wishes to join Startup Y. Startup Y only has a very limited amount of funds available and cannot compete in terms of base salary, but it is willing to offer shares of its product which, in the long run, could turn out much more anyways.

Employee X believes in the product and the assumption, that the shares will be worth much more in the future. Since he is going to fill in the roll of the CTO, he will start of with 5% of the overall company shares, perhaps derived from a predetermined pool of employee equity.

The company is currently looking for funding at a 1 Mio USD valuation. Hence, the 5% are worth 50.000,00 USD at this moment of time. The future CTO and the company agreed on a vesting period of three years, and that the vesting is supposed to be non-uniform, meaning that he will get 1/6th of this shares after one year, 1/2 of his shares after the second year and all of his shares after the full three year period is over. As long as all of the conditions as defined in the “Bad Leaver Conditions” have been satisfied, that is.

Bad Leaver conditions

“Bad Leaver Conditions” are meant to describe a set of circumstances that will prevent the employee (future shareholder) from receiving his shares if he or she does something that harms the company, and typically means any of the following:

1.  The termination of the Employee’s employment with the Company by the Company for cause; (= your employee decided to harass other coworkers, doesn’t come to work any longer or whatnot)

2. the termination of the Employee’s employment with the Company by the Employee without cause; (= your employee decided to take a job at a different company, obviously, he is no longer eligible for your company’s equity)

3. the Employee not devoting substantially all of his efforts to the Business, as determined by the Company; (= your employee no longer does what he was hired to do)

4. the Employee engaging in an activity that could reasonably be seen as competing with the Business, as determined by the Company; and (= your employee selling corporate secrets to a competitor)

5. the Employee breaching the terms and conditions of this Agreement or violating his duty of loyalty to the Company. (= your employee doing anything that could reasonably seen as a breach of trust or breach of loyalty)

6. Whatever else you deem necessary or relevant to determine an employees ongoing commitment. Some vesting / subscription agreements take into account the completion of pre-determined milestones, other require the meeting of certain goals.

Useful terms

A “vesting period” is a period of time an investor or other person holding a right to something must wait until they are capable of fully exercising their rights and until those rights may not be taken away. In cases of partial vesting, a “vesting schedule” is a table or chart showing the portion of a right that is vested over time; typically the schedule provides for equal portions to vest on periodic vesting dates, usually once per day, month, quarter, or year, in stair-step fashion over the course of the vesting period. Often there is a cliff by which the first few steps in the graph are missing, so that there is no vesting at all for a period (usually six or twelve months in the case of employee equity), after which there is a cliff date upon which a large amount of vesting occurs all at once. “Graded vesting” (vesting after each year until the employee is fully vested) may be “uniform” (e.g., 20% of the compensation vested each year for five years) or “non-uniform” (e.g., 20%, 30%, and 50% of the compensation vested each year for the next three years).

Useful templates

Equity for advisors

Here is a template I found very useful to determine the level of equity compensation for advisors. I recommend to check it before agreeing on anything specific, simply because there are those among the advisors out there who wish nothing more than to grab some shares from as many companies as possible, without the motivation of adding actual value. It’s also something you can print out and put in front of a potential investor, asking him, “Where do you see yourself here?”

Equity for employees

The following is a Subscription Agreement that was initially set up for a UK Ltd. Therefore, some legal parts might be different with other corporate entities such as an Inc., a GmbH or a LLC, however, it could help you drafting a first version or save you some legal expenses.

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