As a startup looking to attract talent to your new company, there are few ways more tried and true than offering equity to your employees. One of the most common questions that founders have when starting an equity compensation plan is how to determine the appropriate vesting schedule for the awards. The vesting schedule determines over what period of time, or based on what trigger, the employee will have earned the options and be able to exercise them. There are an endless array of vesting schedule possibilities, and the schedule you choose should really be based on the purpose and goals of your equity compensation program.

What is the purpose of your equity award plan?

The first step is to determine whether your equity award plan is intended as part of base compensation, or a bonus incentive. For many startups that are low on cash and therefore paying below-market salaries, the equity is essentially at-risk base compensation with an upside, meant to compensate for the lower salary. In that case you may need a schedule that allows employees to earn their shares more frequently. For example, a little up front, 20% after one year, and then monthly. If you are paying a more market rate salary, and the equity is really an incentive to drive loyalty and performance, then annual vesting will work.

What are common and competitive practices in your industry?

Across all of the clients we’ve served, the equity plan design also varies by industry. More traditional industries like financial services tend to use annual vesting, where tech companies are more likely to use monthly vesting (often with an initial three to twelve month cliff). If you’re using your equity plan to attract talent, then the more you can learn about what other companies are doing in the industry, the better.

The most common startup schedule we’ve seen over the past few years is a 36 to 48 month schedule with a 1 year cliff (something like 20-25% vests after the first year), and then monthly after that. Most startups also have some sort of acceleration trigger if the company IPOs or is acquired at a certain valuation.

Is performance vesting appropriate?

While most startups use simple service-based vesting (i.e., the amount of time the employee or consultant is engaged with the company), performance vesting triggers are a great tool for some startups. Performance vesting schedules are triggered by a specific goal or event being achieved. In technology companies we sometimes see these on sales or earnings targets, or on patent achievements. At biotechs you can use trial completion or approval stages. Performance awards are extremely popular for public company executives because of shareholder votes and “say on pay” rules. They can be very effective for private companies as well, but can be difficult to implement if you aren’t at a stage yet where you can identify measurable, realistic goals in a particular time frame.

Needless to say, all of this can get quite complicated to track, particularly as you grant more awards over the years and vesting schedules overlap. This is why using software to track your equity plan can make things much easier, as well as more accurate. Feel free to visit our site, OptionTrax, for more information. Vesting is just one aspect of your equity award plan, but from the employee perspective it’s one of the most important, so making sure you get it right up front is worth the effort!