How Long Should Founder's Equity Be Vested?

Dec 06, 2022 2:36 pm

Before we answer the question of duration, let’s establish what equity vesting means.

Equity or share vesting means that the rights to the shares of a company will be earned over a period of time and not outrightly.

It means that if you’re given a 20% equity in a startup, you don’t immediately get access to the entire 20% immediately.

You earn them piecemeal over time. This is called a vesting schedule.

Now, let’s answer the question of how long should founders' shares be vested.

To be honest, there is no hard and fast rule about how long the founder’s equity should be vested for.

I have had Startups who say they want to Vest for 2 years I’ve also had another who insisted on vesting for 7 years.

Basically, there is the ideal vesting period and then there is what the founders or parties want.

The ideal equity vesting schedule is a 4-year period with a one-year cliff period.

What this means is that founder whose shares are vested can only have 100% access to their shares over a 4-year period.

Using a four-year vesting, the shares typically vest at 25% per year.

If you’re using a 2-year vesting, they will vest at 50% per year.

Now the Cliff period in the vesting schedule means that, if a Co-founder leaves the Company for any reason before the end of one full year, he gets absolutely nothing, regardless of how much equity he was given.

The shares automatically revert to the Company.

If he stays with his Company for two out of the 4-year period, he only gets 50% out of his total equity.

Asides from the ideal vesting period, there is what the parties want.

And what the parties want is largely based on their, vision and the eventual exit plan of the founders.

If the desire is to build the business and scale it within 5 years and maybe sell out and exit, the likely vesting period will be 4 years and a one-year cliff period.

If the desire is ti IPO, of course going public as a Startup takes a longer time even as much as 10 years, the vesting schedule will most likely be 7 years or more.

Remember that the exit strategy of the founders must have been determined and communicated to all stakeholders as early on as possible.

If however, the desire is to run the business as a going concern and as a major cash cow, the vesting period may just be long enough for the Company to be able to stand on its own.

As I wrap up, let me add that equity vesting does not have to be time-based alone.

it can also be based on some performance metrics especially if the ownership of shares in the Company is tied to the performance of services in the company.