Nice try, new grad.
The four year vesting schedule doesn't make sense
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Re: The four year vesting schedule doesn't make sense
#12I don't agree with this at all. Vesting schedules are an extremely important component of how equity in a company is awarded, and the one year cliff is an essential part of the formula.
Options are priced, when they are awarded, to have no present value. The exercise price of the option (the cost to buy a share) is equal to the current market value of the share. Furthermore, you can only hold the options for as long as you are an employee of the company. If you leave, you typically have 30 - 90 days to exercise (buy) whatever options you have vested, if you so choose.
Options are worthless when their exercise price is The value of incentive stock options is simply the value of being able to profit from increased market cap without having to actually risk or tie up any of your own money. On the CBOE (options market), you can buy options with a strike price equal to the market price, but with a set expiration date. The option has no inherent value, but the farther out that expiration date, the more "time value" the option has. I think LEAPs max out at expiring 3 years out. Incentive stock options however will typically have a 10 year expiration date. Just look at the time value of 3 year LEAPs and you will start to see how much time value a 10-year option actually has.
More importantly, the primary purpose of giving your employees options is to increase employee retention and align employees' and investors' goals. The secondary purpose is to reward employees when their contributions add long-term value to the company well beyond the scope of their salary. That type of exceptional contribution is never about 'cranking out code' for a few months to add some new feature. It happens when key employees bring with them a sort of magic which helps their team or even the entire company perform at a higher level. These are the people you want holding a meaningful equity share of your company.
If you ever run a company, it will fundamentally change how you look at these things. For example, you start to see all the taxes being confiscated from the money you are paying your employees (payroll, income, state, etc.) are taxes that the company is paying in order to reward their employees. There is no "company share" / "employee share". All that matters is how much money actually makes it to your employee's bank account. The more efficient the company can make the transfer of wealth, the less money comes out of company coffers.
Options, at least for now, are a more efficient way to pay your best employees so that they are equitably rewarded for the contributions they are making. After a certain point it's just too inefficient to try to compensate your key employees with a pay check ("the taxes are too damn high").
When options are part of an offer letter, those options should always have at least a 1 year cliff. It's pointless handing vested options to a new hire if they're going to be leaving and exercising them just a few months after they've been priced. In that case the options likely haven't appreciated, the employee has likely not made an unpredictable and lasting contribution, the employee is demonstrating they don't believe in the company, and furthermore the first year you work at a company is the likely the easiest year to establish a value for the services you'll be providing, and that should be paid out as salary.
Re: The four year vesting schedule doesn't make sense
#13It makes sense when there's real equity being disbursed. One person has $500,000. The other has sweat equity. How do you calculate the relative value of the latter? Come up with a fair salary, and turn it into equity. Four years is a good starting estimate, but if the person leaves early, then the assumption on which the equity level was set is invalidated. I'm against cliffs, though.
Being against the one-year cliff means you either (a) believe you will never make a hiring mistake or (b) believe that it doesn't matter who holds equity in your company. Both are dangerous assumptions.
Not having a cliff doesn't even help employees. It creates a culture where new hires need to be on the defensive from the moment they're hired, because management is strongly incentivized to release new hires as soon as they can to contain the damage of bad hires. In cliff vesting companies, management has a full year to figure out whether someone's going to work out, which is good, because most equity-compensated jobs have ramp-up periods.
Re: The four year vesting schedule doesn't make sense
#14What a terrible idea. If people don't want to stay for even a year, they don't need equity in a startup. That's what salary is for. And getting 1/4000th of the first year's equity grant after the first month won't motivate anybody who understands math, which is probably a trait that startups are looking for.
The idea is that the longer you stay with the company, the larger percent of your remaining equity you get per period. Hockey-stick equity, if you will ;) I think it's actually a pretty reasonable approach. I've had people straight-up tell me during interviews that they're leaving their current position because they've reached either their one-year cliff or their four-year package and want a new opportunity with pote…
The 500-shareholder limit is not a problem for employee options. You just use RSUs, or similarly place restrictions on common stock from being traded until it is registered. (IANAL)
Re: The four year vesting schedule doesn't make sense
#15A company is unlikely to want the overhead of option/equity paperwork (and cap-table complications) for some restless joker who leaves after a few months. Nor are they likely to want an official policy of offering discriminatory vesting-schedules by candidate age.
Re: The four year vesting schedule doesn't make sense
#16I don't invest in companies, but if I did, having nonstandard vesting schemes would be a no-deal red flag, at least for any team that didn't have a mile-long pedigree starting and successfully building companies. Vesting is one of the most important protections the operating team has against hiring (and foundational) mistakes, and anybody who has ever started a company knows those mistakes happen routinely.
Some things to keep in mind when you feel the urge to twiddle the nods on how vesting works:
* It can take 2-4 months, maybe even more for senior hires, to discover whether a new hire is going to fit with the team.
* Your rational incentive for allocating ownership of the company to someone who doesn't belong on your team is zero or worse. You are helped not-at-all by the warm fuzzies a fired employee gets when they contemplate their options, but you are harmed immensely by the share of the long-term upside that those employees take from everyone who comes after them and executes well.
* Equity grants are not just a proxy for future money. They're legal contracts that can drastically complicate later bizdev events. You don't want a large pool of former employees wandering around with executed options. Think of every such person as a P>0.10 risk of a lawsuit threat.
* It is very hard (often virtually impossible) to claw ownership stakes back from former employees. You will, P>0.90, discover candidates later in the life of the company that you'd love to entice with an ownership stake. You will, P>0.90, have a cofounder or employeeDon't fuck around with vesting. Do what your lawyer says, or get one to sign off on the standard four-year+1-year-cliff scheme for your state. If you want to incentivize people to stay with your company for a year, pull other levers to make that happen. Don't pull the vesting lever for something as simple as "students just out of school have shorter time horizons".
Re: The four year vesting schedule doesn't make sense
#17What a terrible idea. If people don't want to stay for even a year, they don't need equity in a startup. That's what salary is for. And getting 1/4000th of the first year's equity grant after the first month won't motivate anybody who understands math, which is probably a trait that startups are looking for.
The idea is that the longer you stay with the company, the larger percent of your remaining equity you get per period. Hockey-stick equity, if you will ;) I think it's actually a pretty reasonable approach. I've had people straight-up tell me during interviews that they're leaving their current position because they've reached either their one-year cliff or their four-year package and want a new opportunity with pote…
I've had people straight-up tell me during interviews that they're leaving their current position because they've reached either their one-year cliff or their four-year package and want a new opportunity with potentially higher gains.
The person who told you "I'm looking because I just hit my first-year cliff" actually told you "DO NOT HIRE ME". Listen harder.
People do leave when they hit four years. Four years is a long time! Some teams are O.K. with this, but if you're not, there's no reason to mess with vesting to solve the problem; just grant them more of the employee pool to stay.
Everyone is always looking for better opportunities. That's fine. Be the best opportunity for everyone on your team, or get better at recruiting. Vesting can't help you with this problem, but it sure can hurt you.
Re: The four year vesting schedule doesn't make sense
#18As someone with his not yet successful company, I am against 1-year cliffs. I believe in the 6-month cliff and am considering dropping it to 3 months.
When I make a poor hiring decision, I usually know within 2-3 months. A shorter cliff forces me to evaluate new-hires faster. No one needs 1 year to determine if a new hire was a good fit.
Re: The four year vesting schedule doesn't make sense
#19Suppose someone (highly qualified, not from the startup world however) can tweak your marketing message for a couple of weeks (i.e. work on your startup for 80-150 hours intensively) and as a direct consquence get you an audience of millions, because your message is now awesome. This person doensn't care about startups.
Say you are pre-money. How should you pay for this person's time?
You would think, if this person can really work for two weeks and give you a company that is worth seeding at a high valuation (due to traction), which also becomes a good signal and thereafter with the company's fantastic traction, money, and engaged audience, it has fantastic growth prospects - but without these two weeks will simply languish as another "project" - then a two percent stake with no cliff whatsoever is a no-brainer.
Re: The four year vesting schedule doesn't make sense
#20As an undergraduate at a top tier CS school, I have seen a lot of companies boast about these vesting schemes. Honestly, I don't think most new grads consider them due to the 1 year cliff. Most people I talk to will say "Well, if I want to leave, the new signing bonus/RSU package will just make up for the lost RSUs."
What really hurts companies is the drawn out exponential vesting periods. I believe Amazon does a package that is 15% after the first year, 40% after the second, 75% after the third, and 100% after four. Maybe my numbers are off, but you are rarely going to get new grads to commit to four years, even with that scheme. I'll take my 25% at another company after a year and move on.
Anyways, the work/experience/location/culture/salary is usually more of a factor than the vesting schedule.