Vesting Schedules

Everything you need to know about how vesting schedules work for stock options and RSUs

Pre-Read: Key Questions This Article Answers

• What is a vesting schedule, and how do they work?

• Why do companies use vesting schedules?

• What is a "typical" vesting schedule?

• What is a cliff?

What Is a Vesting Schedule?

A vesting schedule specifies when an individual employee earns into a portion of their stock options or RSUs. Nearly every stock-comp grant has a vesting schedule.

• The vast majority are time-based, meaning portions of the grant vest over time according to the schedule (e.g. shares vest quarterly over 4 years, with a 1-year Cliff)

• A small minority are based on achieving a certain goal. For example, the shares vest when the firm achieves a specified revenue run-rate, or company valuation.

Companies typically issue grants with many different vesting schedules. For example, a company may have a standard grant structure/vesting schedule for a new hire, a different grant structure for existing employee "refresh" grants, and a different grant structure again for senior leadership. Also, these may have changed one (or more) times over the company's life.

Why Do Companies Use Vesting Schedules?

Companies use vesting schedules to align employee incentives with the company’s long-term success:

Reward Employees With Ownership Over Time

While we all know that time worked does not directly equal value-added, it's a reasonable proxy. This is why the material majority of grants have a time-based vesting schedule.

Ensure Individuals With a Short Tenure (e.g. 6 months) Receive Little/No Equity

The ROI of an employee with a very limited tenure is likely low (if not negative, given the time investment of training). Unvested shares are forfeited if an employee leaves the company, and most new employee grants include a 1-year Cliff, typically resulting in no shares vesting to an individual who is employed for an unexpectedly short time period.

Companies Frequently Provide New Grants to Employees Over Time

As employees are promoted, receive raises or bonuses, or work for the company long-term, companies often provide them with additional grants to continue incentivizing and aligning interests. For many of the same reasons above, refresh grants also have vesting schedules (typically 2-4 years in length).

How Vesting Schedules Work: Primary Components

Vesting schedules determine when you will gain ownership of equity compensation over time. They are made up of several key components:

• Vesting start date is when vesting begins for a stock grant. For a new hire, this is typically your start date. For an existing employee, these may be retroactive, or potentially even in the future.

• Vesting schedule frequency is the frequency at which vesting occurs, such as monthly, quarterly, semi-annually, or annually. Monthly or quarterly vesting is the most common.

• Vesting length is the total length of time over which vesting occurs. Four years is typical, though vesting periods may be shorter or longer.

• Cliff is a period of time (typically one year) before any vesting begins. Once the cliff period ends, employees receive all accrued vesting at once in a lump sum. After that, vesting continues according to the regular schedule.

4 Year Vesting; 1 Year Cliff

Grants that vest over 4 years, with a 1 year cliff, as the most common type of grant issued to new employees

4 Year Vesting; No Cliff

For an employee refresh grant, it's relatively common for grants to not have a Cliff

2 Year Vesting; 1 Year Cliff

Grants vesting in less than 4 years are somewhat uncommon, but definitely exist.

Less Common Vesting Schedule Components

For a number of reasons, companies may utilize some less common features in their vesting schedules. This is typically done with the intent/belief that it will better align incentives, and is more common to see with grants for key employees and senior leadership.

Staggered Schedule

Staggered Vesting Schedule

With a staggered schedule, portions of equity vest differently over different periods.

The most commonly granted are "backend weighted", which vest less in the earlier time periods, and more in the later time periods. This incentivizes a longer-term commitment to the company, as a higher percentage of equity does not vest until the final year(s). For example, a 10/20/30/40 schedule would have 10% of the shares vest in Year 1, 20% in Year 2, 30% in Year 3, and 40% in Year 4.

Less common (but they do exist) are "frontend weighted", which vest more in the earlier time periods, and less in the later time periods.

Note: backend staggered vesting schedules are more common for senior leadership. Back-end weighting stock grants incentivize senior leaders to remain with the company for a longer period of time (e.g. to greenlight + see-through key projects that may have a multi-year payback)

Performance-Based

Performance-Based Vesting

Performance-based vesting ties vesting--in whole, or in part--to achieving a milestone rather than being strictly based on tenure. They're predominately used/granted to incentivize senior leadership (and reciprocally, are rarely granted to employees or middle management).

Performance-based grants can have one or multiple criteria for vesting. The two most commonly used types are:

Single Criteria (fully vest when milestone is met)

Single criteria grants are functionally binary. They specify a milestone and a time period in which to achieve it. If/when the objective is achieved, the grant fully vests.

Dual Criteria: Milestone and Time-Vesting

Dual-criteria performance grants are similar to Double Trigger RSUs in many ways (i.e. the individual only vests into the specified shares when both requirements are met). For dual-criteria performance grants, those are:

• Criteria 1: the performance milestone is achieved, and

• Criteria 2: the time-vesting requirement has been achieved

• Example. An individual receives a dual-criteria grant that specifies (i) a performance metric of trailing 12-months revenue exceeding $50 million and (ii) quarterly time-vesting over 4 years. The $50m hurdle is met 10 quarters later, resulting in 62.5% of the grant vesting that day + 6.25% would vest every quarter thereafter (until 100% vested)

Note: Performance milestones must be objective. To avoid any ambiguity (or disputes), performance milestones should be (and almost always are) well defined. Subjective milestones (e.g. “achieving goals to the satisfaction of the CEO”) don't work

Single/Double-Trigger Acceleration

Single/Double Trigger Acceleration

Acceleration provisions refer to rules that speed up the vesting schedule upon the occurrence of certain events like an acquisition. They're rare, and are typically only exist in grants to C-level executives when they're first hired. The two most common types are:

• Single-trigger acceleration: 100% of unvested equity immediately vests upon a change of control.

• Double-trigger acceleration: 100% of unvested equity immediately vests upon a change of control and subsequent involuntary termination of the individuals position.