Four Years with a One Year Cliff is the typical vesting schedule for startup founders’ stock.
Under this vesting schedule, founders will vest their shares over a total period of four years. The one year cliff means that the founders will not get vested with regards to any shares until the first anniversary of the founders stock issuance.
Upon the one-year anniversary, the founders will each vest 25% of their total shares. Vesting will usually occur monthly after the cliff expires.
Here’s what a “4 Years with a One Year Cliff” vesting schedule looks like in a legal document:
“…25% of the total number of Founder1’s Shares shall be released from the Repurchase Option on the one-year anniversary of this Agreement, and an additional 1/48th of the total number of Shares shall be released from the Repurchase Option on the corresponding day of each month thereafter, until all of Founder1’s Shares have been released on the fourth anniversary of this Agreement.”
The “Repurchase Option” is simply the company’s option to repurchase Founder1’s unvested shares upon Founder1’s departure from the startup company. Also, you should note that vesting schedules trigger other complex issues such as tax, so please don’t simply copy the above text and paste it into a stock purchase agreement.
This is a re-post of an article that I wrote about common founder mistakes for StartupLucky.com and Killerstartups.com (not sure if it went out yet).
1. Spending Too Much Time Keeping Your “Unique” Idea Top Secret. Some founders attempt to have everyone within 25 feet of them sign an NDA. Instead of spending time drafting and then obtaining signatures on a NDA, a founder should use that time to implement the unique idea. It’s highly likely the idea isn’t unique, and a founder could turn off some good investors/partners/mentors by asking for a NDA signature.
2. Not Vesting Founders’ Shares. It’s easy to believe that vesting your own founder shares doesn’t help you, but take a look around the founder table. Now think how you’ll feel if your co-founder decides to try out for American Idol and take his 33% of his vested ownership with him to Hollywood while you and the rest of the founders pound keyboards all day and night.
3. Forgetting to Make the 83(b) Election. If you decide to vest your founder shares, don’t forget to make an 83(b) election with the IRS. You have 30 days to do so after purchasing your founder shares, but there’s not reason to wait more than 1 day post-purchase.
4. Issuing Preferred Stock to Minor Seed Investors Like Your Uncle Bob. Sure, Y Combinator and TechStars get preferred stock for their $18,000 seed investment, but your Uncle Bob (probably) is not Paul Graham or David Cohen, Uncle Bob is not running a startup mentorship program for your team, nor does Uncle Bob have a massive amount of relevant startup industry connections.
5. Concentrating Only On Valuation When Raising Capital. There’s a reason why term sheets are several pages long. Keep reading after you get halfway down the first page to “pre-money valuation”—there are many important terms on subsequent pages. Also, consider whether the investor or investor group is a good fit for your startup. Don’t choose an investor group solely by the highest pre-money number, if you are lucky enough to have a few term sheets in front of you.
If your startup company launches with more than one founder and your startup plans to eventually be acquired or seek venture funding, your startup’s founders stock should vest over time according to a vesting schedule.
Founding teams might not stay together. And having a missing founder or two with a nice chunk of your startup’s common stock is not a scenario your startup wants when it comes time for an acquisition or venture capital financing.
So instead of the founders getting all their shares of common stock on Day 1, the founders get their stock according to a vesting schedule. The standard vesting schedule for startup companies is four years with a one year cliff and monthly vesting thereafter until the founders reach 100%. The one year cliff means that the founders do not get vested with regards to any common stock until the startup’s first anniversary. Thereafter, the founders get vested every month at an amount equal to 1/48th of the their total common stock.
If a founder leaves before the startup’s first anniversary, the founder leaves without any common stock. If a founder leaves after 15 months, the founder will have 31.25% of his common stock vested (25% after the first year, plus the 2.083% vesting each month for 3 months). Thus, the missing founder leaves the startup with much less shares than if the founders stock had vested immediately. This makes it easier to get the necessary approval (and other issues) to go forward with an acquisition or venture capital financing…not to mention allow you to spend that repurchased equity to new hires/founders.