What Is Vesting: Why It Matters for Startups

Vesting can be a game-changer for startups. It’s not just a technical or financial process—it’s a powerful tool that keeps a startup team motivated, safeguards equity, and ensures a fair distribution of ownership. As startups scale, having a strong vesting framework becomes essential for protecting the interests of founders, investors, and employees alike. But what exactly is vesting, how does it work, and why is it so important?

In this article, we’ll break down the concept of vesting and explain why every startup in Australia should consider it. By the end, you’ll understand how vesting builds stability, attracts talent, and promotes loyalty within a startup team.

What Is Vesting?

Vesting refers to a process where people gradually earn rights to an asset (usually shares or options) over a set period. Think of it as “earning” your ownership of company shares by sticking around and contributing value. This is common in startups because it helps ensure that everyone with a stake in the company has a long-term commitment to seeing it succeed.

For example, a founder or employee might receive shares that vest over four years, meaning they only earn complete ownership of those shares after staying with the company for the entire period.

Why Vesting Is Crucial for Startups

Vesting matters in startups because it keeps equity balanced and protects the company from sudden exits or changes. Here’s why this is so important:

1. Securing the Startup’s Ownership Structure

Imagine if a co-founder left a few months after the startup launched but still held a large percentage of shares. This could create big problems for the remaining team. Vesting protects against this by ensuring that unvested shares return to the company if someone departs early. This helps maintain control and keeps shares available for future hires or investors who may bring new skills, funding, or market insights.

2. Encouraging Loyalty and Commitment

It also helps align team members’ goals with the startup’s vision. Since shares vest gradually, those who hold vested equity are incentivised to stay longer and work harder, knowing they’re part of the company’s future success. This loyalty can be crucial in challenging startup environments where dedication often makes the difference between growth and stagnation.

3. Attracting and Retaining Talent

Startups often can’t offer high salaries like established corporations, but they can offer equity as a long-term incentive. For many professionals, having a vested stake in a growing company is highly attractive. By offering a clear vesting schedule, startups can appeal to top talent and keep them motivated for the journey ahead.

4. Protecting Against Co-founder or Employee Exits

When there’s more than one founder, vesting is essential to protect the startup from a sudden founder exit. Without this, a departing founder could take a large equity stake with them, leaving the remaining team without enough shares to attract talent or investors. By requiring all founders to vest, startups reduce the risk of one person holding too much equity after leaving.

How Does Vesting Work in a Startup?

Vesting is usually structured through an agreement specifying the vesting period, the conditions, and the percentage of shares vested over time.

Vesting Schedule

The vesting schedule determines the timeline for earning equity. The typical vesting period for startups is four years, often with a “cliff” of one year. A cliff period means the person only receives equity after staying with the company for at least a year. This prevents someone from earning shares if they leave too early, which could destabilise the company’s ownership.

Vesting Cliff

A vesting cliff is the period before any shares vest. For instance, if a startup has a one-year cliff, team members must stay with the startup for at least a year to receive any shares. After the cliff period, shares start vesting regularly, typically monthly or quarterly. This gives the company a chance to confirm the person’s commitment before giving them any equity.

Accelerated Vesting

In some cases, startups include provisions for accelerated vesting, which allows shares to vest faster under certain circumstances. A common example is when the company gets acquired. This protects shareholders by ensuring they receive their unvested shares immediately if the startup is sold, preventing loss of potential gains from their hard work.

Types of Vesting Structures for Startups

Different vesting structures suit different startup needs. Here are the two most common types of vesting for startups:

Time-Based Vesting

This is the most straightforward vesting structure. Shares vest gradually over a predetermined period, often monthly, once the cliff is reached. Time-based vesting is particularly effective in startup environments, where it rewards consistent commitment.

Milestone-Based Vesting

In milestone-based vesting, shares vest based on achieving specific performance goals or milestones, not on time. This structure can work well for advisors or consultants, whose contributions may align with achieving measurable objectives. For example, a marketing consultant might vest shares after helping the startup achieve a significant sales milestone.

 

Why Founders Should Be on a Vesting Schedule

Sometimes founders assume they don’t need to vest because they helped launch the company. However, including founders in vesting arrangements protects the startup if one of them decides to leave. Founder vesting also reassures investors that everyone’s commitment aligns with the company’s long-term goals, creating an appealing investment prospect.

Common Pitfalls to Watch Out For

There are some common issues startups should avoid:

Short Vesting Periods

A vesting period that’s too short may fail to adequately protect the company’s equity. While it might be tempting to offer a shorter vesting period to attract talent, remember that a longer vesting period aligns interests with the long-term vision. A four-year period with a one-year cliff is usually the best balance for startups.

Ignoring Vesting for Founders

Not including founders in vesting can lead to issues down the road, especially if one founder leaves. Founders should vest just like employees, to demonstrate commitment and create fair ownership. This is crucial when pitching to investors, who often seek reassurance that founders are equally invested.

Lack of Clarity in Terms

An unclear vesting agreement can lead to misunderstandings or disputes. Startups should ensure their vesting terms are clearly outlined, including the vesting schedule, cliff period, and any provisions for accelerated vesting. A well-drafted vesting agreement keeps everything transparent and builds trust among team members.

Steps to Set Up a Vesting Agreement for Your Startup

Setting up an equity framework doesn’t have to be overwhelming. Follow these steps to create a clear approach:

1. Consult Legal Experts

A legal professional can help draft an agreement that complies with Australian laws and aligns with your startup’s needs. Additionally, a financial advisor can explain how it might impact your company’s tax and equity structure.

2. Define the Schedule and Cliff

Decide on a four-year schedule with a one-year cliff—a popular setup that balances commitment and practicality.

3. Customise Terms for Different Roles

Tailor terms to each role within your startup. For example, founders might benefit from time-based structures, while advisors or consultants may prefer milestone-based terms. Customisation ensures the agreement reflects each individual’s contribution.

4. Include Acceleration and Exit Provisions

Consider adding acceleration clauses for events like acquisitions. This protects shareholders if the startup is acquired, enabling them to receive their unallocated shares sooner.

Building a Committed Team for Long-Term Success

A strong vesting framework is more than just a financial arrangement; it’s a strategic way to secure your startup’s future. By implementing a well-structured plan, startups can build a committed team, attract talent, and maintain stable ownership—all essential for long-term growth.

If you’re launching a startup, consider establishing an equity strategy from day one. A thoughtfully designed agreement can create a foundation for growth, ensuring that everyone working toward your company’s success has a fair and meaningful share in the journey.