Differences Between Founder and Employee Vesting

Vesting is a critical concept in equity ownership, particularly in startups where both founders and employees are often granted equity. However, vesting terms can differ based on who is receiving the equity. This article explores what vesting means in practical terms and how it affects equity ownership.

What is Vesting?

Vesting is the process of earning ownership of company shares or stock options over time. Instead of getting all your equity upfront, you receive it gradually, based on a set timeline called a vesting schedule. This encourages long-term commitment and ensures that equity is only given to those who stay and contribute to the company. A common schedule lasts four years with a one-year “cliff,” meaning no equity is earned unless you stay for at least a year.

Once shares or options are vested and exercised (if applicable), the holder may gain certain rights, such as voting at shareholders’ meetings and potentially receiving dividends, depending on the class and terms of the equity.

What is a Cliff Period?

A cliff period is the minimum amount of time someone must stay with a company before any of their shares or stock options begin to vest. It’s a common feature in both founder and employee vesting schedules and is designed to ensure a certain level of commitment before ownership rights begin to take effect.

For example, a one-year cliff means that if the person leaves the company before completing one full year, they receive no equity at all. However, once they complete the first year, a significant chunk, typically 25% of the total equity, vests all at once. After that, the remaining portion usually vests gradually (monthly or quarterly) over the remaining term of the vesting schedule.

Cliffs help companies avoid giving equity to individuals who leave shortly after joining, while still rewarding those who stay and contribute beyond the initial period.

What is Founders’ Vesting?

Founders’ vesting is a mechanism that ensures startup founders earn their shares gradually over time, rather than keeping them outright from day one. While it might seem counterintuitive since founders are the ones who started the company, investors often require vesting to protect the company’s future and ensure the founding team remains committed.

Typically, when a startup is formed, shares are allocated to the founders early on. However, if one of the founders were to leave shortly after receiving their shares, it could create problems, such as a large portion of equity being held by someone no longer contributing to the company. To prevent this, investors and sometimes the founders themselves introduce a vesting schedule, usually similar to employee vesting — commonly four years with a one-year cliff.

In some cases, vesting may also be achievement-based meaning a portion of the founder’s shares vest only when certain milestones are reached, such as hitting revenue targets, launching a product, or securing key partnerships. This structure adds another layer of accountability by tying equity not just to time served, but also to meaningful progress.

Usually, even before the shares are fully vested, founders gain full shareholder rights, including voting at meetings and receiving dividends. Under these arrangements, the founder’s shares are legally issued but are subject to repurchase or forfeiture if the founder leaves early or fails to meet agreed-upon milestones. This approach aligns the founder’s incentives with the company’s long-term growth and gives future investors and team members confidence in the stability and commitment of the leadership team.

Key Features of Founders’ Vesting

• Applies to already issued shares: Founders typically hold shares outright, but those shares are subject to transfer restrictions.
• Custom terms: While vesting terms can be tailored to company’s specific needs, a standard structure is four-year vesting with a one-year cliff.
• Full rights prior to full vesting: Founders’ shares usually include voting rights and dividend entitlements right from the outset, unless otherwise restricted by the company’s equity structure and governing documents.

What is Employees' Option Vesting?

Employee vesting under an ESOP refers to how employees gradually earn the right to buy company shares through stock options. Unlike founders, who often hold actual shares, employees are usually granted stock options — the right to purchase shares at a fixed price, known as the exercise price, after a certain period.

These stock options don’t belong to the employee outright from the start. Instead, they become available or “vest” over time, based on a pre-agreed vesting schedule. A common schedule is four years with a one-year cliff. This means that no options vest in the first year, but after completing one year, 25% of the options vest. The remaining options typically vest in equal monthly or quarterly installments over the following three years.

This system is designed to reward employees for staying with the company long term and contributing to its success. If an employee leaves before their options are vested, the unvested portion is usually forfeited. This helps companies retain talent and ensures that equity benefits are tied to continued performance and loyalty.

It’s important to note that stock options don’t carry shareholder rights such as voting or dividends until they are exercised and converted into actual shares.

Key Features of Employees' Option Vesting

• Applies to options, not shares: Employees don’t own the shares until they exercise vested options.
• Standardized schedules: Most companies offer a four-year vesting schedule with a one-year cliff.
• Performance and tenure linked: Vesting incentivizes employees to stay and perform over time.
• No rights until exercise: Employees typically do not have voting or dividend rights until they purchase the vested shares through exercising their options.

Key Differences Between Founder and Employee Vesting

While both founders and employees earn equity over time through vesting, the structure, purpose, and mechanics behind their vesting arrangements can differ significantly. Understanding these differences is important for anyone involved in a startup, whether you’re building the company or joining the team. The table below highlights the key distinctions between founder vesting and employee vesting under an ESOP:

Final Thoughts

While vesting serves the same general purpose — ensuring commitment over time — the mechanics differ significantly between founders and employees. Founders usually vest actual shares, often to meet investor requirements or reinforce alignment within the founding team. In contrast, employees typically receive stock options through an ESOP, designed to motivate and retain key contributors. Understanding these differences helps both parties make informed decisions and manage expectations.

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