Choosing the right vesting schedule for your Share Option Scheme

At SeedLegals our Share Option Scheme allows you to design your scheme to suit your company.  We support two main types of vesting schedules:

• Milestone based – if an employee hits a certain milestone (e.g. a certain amount in sales), they will earn a certain number of options
• Time based – an employee will earn their shares over a set period of time, normally 3-4 years.

You obviously don’t want to give someone all of their share options and have them leave the next day. Vesting schedules help to prevent that problem by allowing you to control the rate at which your team gets their options, thereby incentivising them to meet certain performance goals or stay in the company for a minimum period of time. As a founder, you’ll need to decide what type of scheme is right for your company. Let’s look at the pros and cons of milestone based vesting and time based vesting. 

Milestone based vesting

Milestone based vesting aligns your team’s motivations with wider company goals. When done correctly, this type of option scheme can work well, especially for people in your team (such as an adviser) whose main objective is to help your company close its next funding round.

However, as soon as we look to the longer term, milestone based option schemes might not be as appropriate. If you look at your objectives three years ago, the chances are that they’re very different to what they are now. So if the company’s goals change, that can unfairly affect the opportunities for your employees to earn share options.

Also, milestones can often be ambiguous, particularly for people in roles that don’t have metrics which are easily defined. It might be easy to create clear milestones for sales and marketing, but the same may not be said for roles in operations, HR and product. Accordingly, for a company-wide share option scheme that affects all employees, it may be preferable to adopt another type of vesting structure: time based vesting.

Time based vesting

To understand time based vesting, we need to first explain a few bits of jargon. 

Vesting period

The time required for an option holder to earn all of their options given in a grant. For example, if an option holder is granted 100,000 options to be vested annually over a 4 year period, the option holder will earn 25,000 options every year.

Cliff period

The minimum time required before an option holder’s options begin vesting. For example, if an option holder is granted 100,000 options with a cliff period of 1 year, the option holder will only start earning their options after the year has elapsed. A cliff ensures that an option holder only begins to get rewarded if they have stuck with the company for a decent amount of time. If they have only been working with you for a few months, they probably haven’t contributed enough value to have earned the right to any equity in the business.

Vesting frequency

How often the option holder earns shares in their schedule – this could be monthly, quarterly or annually. If you have a frequency of longer than monthly, this can motivate people to stick around until the next portion of options vest – but it could lead to employees leaving the business at a similar time, especially if you choose annual vesting.

Our data

Our data shows us that the most common choice for share option schemes is 4 year vesting with a 1 year cliff and monthly vesting frequency. After the first year, 25% of the holder’s options will have vested and the remaining amount will vest each month, for the next 36 months. 

Time based vesting used to be difficult to administer because you’d have to keep track of exactly how long people have been with you, whether they’ve passed their cliff and more. Now, thanks to SeedLegals, you can track this easily on one dashboard.

As time based vesting most closely aligns employees with founders and is generally seen as the fairest way to allocate options, the vast majority of companies who set up their option scheme on SeedLegals choose time based vesting.

Talk to our Options team

Previously setting up an option scheme was complex, time-consuming and expensive. At SeedLegals, we’ve made it dramatically easier. And as with all SeedLegals services, we’re on hand to help every step of the way.

If you have any questions, or still not sure on the best way to go, we’re here to help. Get in touch with our team who will guide you and help you get started.

*Disclaimer: The information contained in this article does not constitute and should not be treated as legal, tax, accounting, or financial advice.