Vesting schedule

A vesting schedule is the timeline over which equity compensation (stock options, restricted stock, or RSUs) becomes the employee’s property. Unvested shares are typically forfeited if the employee leaves; vested shares remain the employee’s property. Vesting schedules align employee and shareholder interests by creating an incentive for the employee to remain with the company and build long-term value.

Standard vesting structure

The most common vesting schedule in the US is 4 years with a 1-year cliff:

• Year 1: After 1 year of employment, 25% of the grant vests immediately (cliff).
• Years 1–4: The remaining 75% vests monthly (approximately 1.56% per month or 18.75% per year).
• Year 4: All shares are vested after 4 years of employment.

Other structures exist:

• 3 years with a 6-month cliff (common in some European or mature companies).
• 5 years with a 1-year cliff (sometimes for founders or senior executives).
• Straight-line vesting with no cliff (less common; monthly vesting from month 1).

Why vesting exists

Vesting serves multiple purposes:

1. Incentive alignment: The employee has a strong incentive to remain with the company and perform well, because their equity ownership depends on continued service.
2. Retention: Employees are less likely to leave mid-project if they know they will forfeit half their equity.
3. Protection against early departure: If an employee leaves after 6 months, they have earned nothing and forfeit their grant entirely. This is important for startups where early employees must be reliable.
4. Tax efficiency: For restricted stock, vesting creates the event that triggers ordinary income tax, rather than immediate taxation at grant.

The cliff and why it matters

The cliff is the initial waiting period before any equity vests. With a 1-year cliff, the first 25% of equity is forfeit if the employee leaves before 1 year.

Cliffs are essential because:

• An employee who leaves after 11 months should not be rewarded with equity. The cliff ensures they earn nothing for their investment.
• After the cliff, the equity vests gradually, providing a lower hurdle to retention as time passes. An employee 3 years in has earned 75% and is more likely to stay to collect the final 25%.

Without a cliff, an employee could leave after 1 month, vesting a few percent of equity, which is wasteful. Cliffs provide a clean threshold.

Single-trigger vs. double-trigger acceleration

Some grants include acceleration provisions that speed up vesting upon certain events:

Single-trigger acceleration: The full grant immediately vests upon a change of control (acquisition). This is favorable to employees but unfavorable to acquirers (because they lose leverage in post-acquisition retention). Single-trigger is now rare in public company employment, though more common in private companies and for founders.

Double-trigger acceleration: The grant vests only if the employee is fired or if the acquiring company does not assume the grant. This is more common in public companies and gives the acquirer a tool to retain the employee.

Example:

• Employee has 4-year grant, 2 years vested, 2 years unvested.
• Company is acquired.
• Single-trigger: All 4 years immediately vest upon announcement.
• Double-trigger: Vesting continues only if employee remains employed, or accelerates only if employee is terminated without cause.

The double-trigger approach is increasingly favored because it discourages retirees from claiming they were “forced out” to collect early acceleration.

Acceleration upon founder departure or death

For founder shares, vesting is often lighter or waived. A founder may grant themselves fully vested shares immediately (because they created the company and assume full ongoing commitment). Alternatively, founder shares may vest immediately but have a long lockup period before they can be sold.

In some cases, if a founder dies or is forced out (coup d’état), other founders’ shares may accelerate to prevent a co-founder’s family or a usurper from holding significant voting power.

Vesting and taxation

Vesting is often the taxable event for restricted stock. When the employee earns the right to the shares (vesting), they recognize ordinary income equal to the fair market value of the shares on that date (if no 83(b) election was filed).

For RSUs, vesting and settlement coincide. Upon vesting (and settlement of shares), the employee recognizes income.

For options, vesting is not the taxable event. Taxation occurs at exercise, not vesting.

Vesting in private versus public companies

Private companies use vesting heavily to align founders and employees toward building the company for eventual exit. Vesting is a standard term in any funding round.

Public companies also use vesting, but the mechanics can differ. For RSUs, vesting is typically 4 years. For options, vesting is also 4 years but exercise may be immediate (since the option has no intrinsic value if out-of-the-money).

Vesting and golden parachutes

Executive employment contracts sometimes include accelerated vesting upon termination. A CEO terminated without cause might have all unvested equity immediately vest (double-trigger acceleration), providing a “golden parachute” — a substantial cash cushion upon involuntary departure.

This can be expensive for the company but is often necessary to attract strong executives. The tradeoff is to use double-trigger (vesting only if the executive is fired without cause or does not receive a comparable role post-acquisition), not single-trigger (automatic acceleration upon any acquisition).

Variable vesting schedules

Some grants include performance vesting — shares vest only if the company or employee meets certain targets. This is stronger incentive alignment but harder to administer and less favorable to employees.

Other grants have accelerated vesting for high performers or bonus vesting upon hitting milestones.

These variations are less common than the standard 4-year/1-year schedule, which is the default.