Draft Vesting Schedule

Vesting Schedule

A vesting schedule controls when an employee, founder, or service provider earns the right to exercise or retain equity. Without vesting, a co-founder who departs in year one takes their full equity stake — leaving the remaining founders and investors to work for a shareholder who contributes nothing. Vesting aligns long-term incentives with the company's need to retain talent.

When to use this

• Founders establishing a startup and formalizing co-founder equity (before or at the first investment round)
• VC term sheet negotiation — investors require founder vesting as a standard condition
• Equity grant program for employees, advisors, or independent contractors
• Post-acquisition equity rollover (acquirer restructures the seller's equity into a new vesting scheme as retention)

Standard Vesting Structures

Structure 1: 4-Year Monthly with 1-Year Cliff (VC Standard)

• Cliff: 25% of the total grant vests on the first anniversary of the grant date
• Monthly: 1/48 of the total grant vests on each monthly anniversary thereafter for 36 months
• Total: 100% vested at 4 years

Why this is standard: the cliff ensures that very short-tenure employees (or co-founders who leave quickly) receive no equity; the monthly schedule aligns with payroll and is predictable.

Example: 1,200,000 options granted on January 1, 2024

• January 1, 2025: 300,000 options vest (cliff)
• February 1, 2025: 25,000 options vest
• Each month thereafter: 25,000 options vest
• January 1, 2028: final 25,000 vest (fully vested)

Structure 2: 4-Year Quarterly with 1-Year Cliff

• Cliff: 25% at month 12
• Quarterly: 1/16 of the total grant per quarter thereafter
• More employee-friendly than monthly (larger installments, less administrative burden)

Structure 3: 4-Year Annual

• Annual vesting: 25% per year, vesting on each anniversary
• Less common in tech; used in more traditional industries
• Risk: one day before the anniversary, the employee has no unvested shares and may leave without triggering any accelerated cliff/vest

Structure 4: Performance-Based Vesting

Vesting tied to measurable milestones rather than (or in addition to) time:

• Revenue milestones: vest X% on achieving USD Y in ARR
• Product milestones: vest X% on achieving launch / user count / specific product metrics
• Market milestones: vest X% on regulatory approval / market entry

Risk with pure performance vesting: disputes about whether milestones are met; subjective criteria create litigation. Always define milestones with objective, measurable, and verifiable criteria, and include an independent calculation mechanism.

Structure 5: Hybrid (Time + Performance)

• 50% time-based (4-year monthly with cliff)
• 50% performance-based (milestone-triggered)
• Most common for senior hires in growth-stage companies where both retention and performance accountability matter

Required inputs

Acceleration Provisions

Single Trigger

A change of control (acquisition, merger) alone triggers acceleration of unvested shares.

• Founder-friendly: the founder receives full equity benefit regardless of whether they remain employed
• Investor concern: acquirer inherits a large vested equity stake without retention leverage; may depress acquisition price

Common single-trigger: 25–50% acceleration on CIC; 100% single trigger is rare except for very early-stage or sole founders.

Double Trigger (Market Standard)

Two events must both occur:

1. First trigger: a change of control (acquisition, merger)
2. Second trigger: within [12–24] months after the CIC, the employee is terminated without cause, or resigns for good reason (constructive dismissal)

On double trigger: 100% of unvested shares accelerate.

Good reason typically means: material reduction in compensation, material diminution in responsibilities, relocation by more than [50 miles / reasonable commute distance], or material breach of the employment agreement by the employer.

Performance Acceleration

Specific milestones, when achieved, trigger a tranche of performance-based vesting. The milestone definition must be airtight.

Good Leaver / Bad Leaver

Good Leaver

• Definition: resignation without cause; termination without cause; death; permanent disability
• Outcome: retains all vested shares/options as of the departure date; unvested shares forfeited (or subject to repurchase at fair market value, not par value)
• Options exercise window: extended to [12 months] from the good-leaver departure date (contrasts with the standard 90-day post-termination exercise window in most option plans)

Bad Leaver

• Definition: termination for cause; resignation in breach of contractual obligations; violation of non-compete
• Outcome: may be required to forfeit or sell vested shares at par value (or at a low repurchase price); unvested shares forfeited
• Note: bad-leaver provisions allowing repurchase of vested shares at par are standard in VC-backed companies but uncommon in US startup practice where vested shares are generally inviolable; in DIFC/English-law structures, these provisions are enforceable if clear and for consideration

Death / Disability

• Standard: 100% acceleration (all unvested shares vest immediately)
• Rationale: the vesting period was intended to retain the individual; neither party can be held to a retention schedule when the individual is unable to perform
• Options exercise: transfers to estate; extended exercise window

Departure Treatment Summary

Tax Considerations

US — Section 83(b) Election

When restricted stock (not options) is subject to vesting, the IRS treats unvested stock as received for tax purposes only when it vests — which may be at a higher value, creating a larger tax bill. A Section 83(b) election:

• Filed within 30 days of the grant date (no extensions; if missed, the election cannot be made)
• Elects to treat the stock as received at the grant date (when the value is typically close to zero for a startup)
• Tax: income tax on (FMV at grant - price paid); often near zero for early-stage founders
• Capital gains clock: starts from the grant date, giving longer capital gains holding period

This is the single most important tax planning step for US startup founders and early employees.

UK — EMI Options

Enterprise Management Incentive (EMI) options are a UK HMRC-approved option scheme with favorable tax treatment:

• Qualifying companies: must meet size criteria (gross assets < £30M; fewer than 250 full-time equivalent employees); trading company (not investment)
• Tax benefit: EMI options granted at market value; no income tax on exercise; capital gains tax (CGT) rates apply on disposal; Business Asset Disposal Relief (BADR) may apply (10% rate on qualifying gains)
• Non-EMI options: income tax on exercise (the spread between exercise price and FMV); employer NI also due; less favorable

UAE — 9% Corporate Tax and No Income Tax

• UAE introduced federal corporate tax at 9% effective June 2023 (for financial years starting on or after June 1, 2023)
• Individuals: no personal income tax; equity compensation received by UAE-resident employees does not trigger personal income tax
• Employer implications: the corporate tax treatment of equity compensation expense for the employer depends on accounting standards and the UAE Corporate Tax Law; advice from a UAE tax adviser is needed for companies with significant equity plans
• DIFC / ADGM: same (no income tax; entity-level corporate tax)

KSA

• No personal income tax for Saudi nationals
• Non-Saudi employees: Zakat on Saudi-owned portions; income tax on foreign employees' income (20% on non-Saudi employees unless treaty applies)
• Equity compensation for foreign employees in KSA: the income tax treatment of options/RSUs depends on timing of vesting and exercise; KSA General Authority of Zakat and Tax (GAZT, now ZATCA) should be consulted

Documentation Chain

Equity compensation requires a stack of coordinated documents:

1. Stock Option Plan / Equity Incentive Plan: the overarching legal document adopted by the Board and shareholders; sets out the total pool, the types of equity instruments, eligibility, vesting framework, and plan administration. Without an adopted plan, individual grants cannot be made.
2. Grant Letter / Option Agreement: the individual document evidencing each grant — grantee name, grant date, number of options, class, exercise price, vesting schedule, applicable acceleration, good/bad leaver treatment, and governing law. Must be consistent with the plan.
3. Vesting Schedule Exhibit: the visual schedule (table or chart) showing cliff date and monthly/quarterly vesting dates, typically attached to the Grant Letter.
4. Notice of Exercise: the form the grantee uses when they elect to exercise vested options; must include payment of the exercise price.
5. Notice of Cancellation: used on bad-leaver forfeiture or lapse of unvested options; confirms the options have lapsed.
6. Shareholders' Agreement amendment: if the option plan creates new rights (information rights, co-sale, etc. for option holders), may need an SHA amendment.

Common Mistakes

• No vesting on founder equity — the most common early-stage oversight; a co-founder who departs in year one retains full ownership; no vesting = no protection for remaining founders and investors
• Missing the 83(b) window — US founders who do not file within 30 days of grant lose the ability to elect; the tax impact on a successful exit can be hundreds of thousands of dollars
• Cliff not set correctly — "4-year vesting with 1-year cliff" that starts on the company founding date but the grant is made 6 months later means the founder effectively has a 6-month cliff, not a 12-month cliff; always state the grant date and cliff date explicitly
• Acceleration without definition of "cause" — double trigger requires a definition of "cause" and "good reason"; if undefined, the acceleration trigger is disputed on every exit
• No exercise window extension — standard option plans have a 90-day post-termination exercise window; many departing employees miss this window; consider extending to 12 months for good leavers (particularly important for options with high exercise prices)
• Bad leaver repurchase at par without consideration — a clause that forces a bad leaver to sell vested shares at par with no alternative consideration may be challenged as a penalty clause in English-law jurisdictions; ensure the forfeiture mechanism has appropriate consideration

Related skills

• [[draft-shareholders-agreement]]
• [[draft-term-sheet-vc]]
• [[draft-employment-contract]]
• [[draft-safe]]