Summary
- Share vesting is a process by which co-founders and employees earn their equity over time, typically over four years with a one-year cliff, meaning no shares vest if they leave before the first year is completed.
- After the cliff, 25% of shares vest at the one-year mark, with the remainder vesting monthly until 100% is reached at four years, though schedules can be structured flexibly including milestone-based vesting.
- Share vesting protects the business if a co-founder departs early, incentivises long-term commitment, and signals to investors that founders are dedicated to growing the company.
- This article explains how share vesting works for startup co-founders and early-stage investors in Australia.
- LegalVision, a commercial law firm specialising in advising clients on startup law and equity structuring, outlines how vesting schedules work and why they matter to investors.
Tips for Businesses
Document your vesting schedule in a formal share vesting agreement from the outset. Consider whether a cliff is appropriate and whether backdating to when founders began working is warranted. Be aware that later-stage investors may require founders to re-vest shares as a condition of investment.
Share vesting determines how and when co-founders earn their equity in a startup. Founders receive shares gradually over time, rather than all at once, tying ownership to continued commitment. This structure protects the business if a co-founder leaves early and signals to investors that the founding team is in it for the long haul. This article explains how share vesting works and what its structure suggests to potential investors.
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What is Share Vesting?
A startup can either have vested or unvested shares. A vested share is one that you can act on and sell. An unvested share is one that you can act on and sell after a period has passed, or an event occurs.
Time-Based Vesting
A typical arrangement is that shares will vest after a period of time (usually four years). The vesting period commences after a specific period (usually one year) from when the co-founders agree (known as the ‘cliff’). Practically, a co-founder will get nothing if they leave the company before the first year has passed. Implementing a cliff can be helpful in protecting against early departures and ensuring that the co-founder or employee bound by the vesting condition has meaningful commitment. At the one-year mark, generally 25% of the shares will vest and then, from that point onwards, they vest at just over 2% per month until you reach 100% (assuming they vest monthly over a further 3 years).
| Period of Time | Shares Vested |
|---|---|
| Up to One Year | 0% |
| At One Year | 25% |
| At Two Years | 50% |
| At Three Years | 75% |
| At Four Years | 100% |
You can structure your vesting period flexibly. For example, you may not require a cliff, or you may backdate to when you and your co-founder(s) first started working on the idea – even if you did not incorporate the company until later down the track.
Other Forms of Vesting
While less common than time-based arrangements, vesting can also occur when the business, or co-founder, achieves particular milestones. For example, revenue targets or particular key performance indicators.
Why is Share Vesting Important?
Broadly speaking, share vesting has three purposes:
- Incentivise the co-founder or employee to stay working in the business so that their shares vest;
- Protect the business if a co-founder or employee leaves; and
- Signals to investors the founder’s commitment to growing the startup.
If a co-founder or employee leaves, they will only receive the benefit of the shares that have vested. Otherwise, they will receive no benefit at all if they leave before reaching the vesting cliff. This arrangement can potentially cost the co-founder or employee a significant amount of money if the shares they are forfeiting are (or could be in the future) worth a substantial amount of money.
Share vesting is also beneficial for your investors. A share vesting agreement can help mitigate risk, protect your startup and demonstrate to investors that you are committed to growing the company. Founder vesting is often a key item within a term sheet and discussed with the lead investor during the early pre-seed and seed rounds.
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When is Share Vesting Relevant?
Co-founder Exit
Running a startup is stressful. Juggling an often untested idea with access to limited capital in a dynamic market will often cause friction between co-founders who may have different ideas about how the company should operate. Unsurprisingly, this environment can lead to disputes – some of which may result in the relationship between co-founders breaking down.
Future Investment
Later-stage investors, such as venture capital firms, are less likely to invest in a startup if the remaining co-founders hold only a small portion of the equity. Investors view co-founders who only hold a small portion of equity as less incentivised to continue shouldering the stress of growing the business. If you secure funding, your investor may also require you to re-vest your shares.
Key Takeaways
Share vesting is a process where co-founders earn their equity over time, typically over four years with a one-year cliff. If a co-founder leaves before the cliff, they forfeit unvested shares. After the cliff, shares vest monthly. This structure ensures that co-founders remain committed to the business and reduces the risk of early departures. It also reassures investors by demonstrating the long-term commitment of the founding team, which enhances the startup’s attractiveness to potential investors. Implementing a clear share vesting schedule can help align the interests of co-founders and investors, providing greater stability for the business.
If you are drafting a share vesting agreement, LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced startup lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
Share vesting is a process where co-founders earn their equity gradually over a set period, usually four years, with a one-year cliff. If a co-founder leaves before the cliff, they forfeit their unvested shares.
Share vesting ensures that co-founders are committed to the business long-term, protecting the startup from early departures. It also builds investor confidence by demonstrating the team’s dedication to the company’s success.
If a co-founder leaves before reaching the cliff period, typically one year, they forfeit all their unvested shares and receive no benefit from them. This protects the business from early departures and ensures only committed co-founders retain equity in the startup.
Yes. Vesting arrangements are flexible and can be structured without a cliff, backdated to when co-founders first started working on the idea, or tied to milestone-based events such as revenue targets or key performance indicators, rather than time alone.
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