Pros and cons of share vesting

Pros and cons of share vesting

Linkilaw Startup Advice & Tips

This article is the second part of a four-part series dedicated to share vesting. Check out the first article in the series: What is share vesting? 

In the last article in our share vesting series, we defined share vesting as the process by which an employee, investor, or co-founder is rewarded with shares or stock options but receives the full rights to them little by little over time. We outlined some important reasons to consider using share vesting, whether your goal is  retaining talent, demonstrating commitment, or protecting your business.

In this article, we’ll go into a little more detail about the three main benefits of share vesting—preserving your cash flow, employee retention and employee productivity—as well as the precautions you should take to ensure the growth of your company.

Pros and cons of share vesting

Pro: Preserving your cash flow

Particularly if your company is in its infancy, minimising unnecessary expenditures is vital. One of the top benefits of using share vesting is protecting your cash flow by using equity instead of cash, but in a way that ensures the recipient performs their obligations in the long term.

One of the most famous stories about using equity instead of cash occurred in 2007 when Mark Zuckerberg commissioned artist David Choe to paint a mural in Facebook’s headquarters and paid him with Facebook equity. At the time, accepting Facebook shares instead of cash was seen as a gamble, but when the company went public in 2012, Choe’s shares were valued at approximately $200 million.

The moral of this Facebook story is that using equity instead of cash allows you to pay with equity by leveraging your company’s potential. Using share vesting in the payment terms helps you gain the benefit of leveraging your equity for long-term relationships.

Pro: Employee retention 

Employee turnover can slow your business down and hurt your cash flow. In a startup environment where time and cash are extremely valuable resources, minimizing turnover is a top priority.

As noted in the first article in this series, share vesting is a very useful tool to retain top talent as well as keep them loyal to your company. Studies have shown that employee turnover rates are lower for employees who have not completed their vesting period. The expectation of future gains incentivises current employees to remain with your company, particularly when your business is in its growth stages.

Pro: Employee productivity

Using share vesting (and equity in general) as part of an employee’s compensation can also improve employee  productivity.

Giving an employee shares effectively makes them a part-owner of the company. Although their ownership is usually relatively small, even a small percentage of company equity can shift an employee’s mindset from thinking about what’s best for them on an individual level to thinking about what’s best for the company.

Using share vesting in an employee equity arrangement makes this situation even more of a win-win for founders and directors—the employee develops an ownership mindset from the start, while the company takes on less of the risk associated with giving away equity.

And, if you outline the conditions of share vesting wisely, it has the potential to incentivise your employees to perform better by promising an equity reward for certain performance milestones and outcomes. (We’ll talk about the different types of vesting schedules in the next article.)

Risk: Choosing the wrong vesting period

Nothing is ever perfect, and this truism extends to share vesting as well. Although there are serious benefits to using share vesting, there are also certain precautions that you should take when organising a vesting scheme for your employees or partners. The first of these relates to choosing the wrong vesting period.

As we’ve mentioned, share vesting is a common way to lure top talent. However, vesting in and of itself may not seal the deal—the shares need to vest within a reasonable amount of time for the offer to be attractive. It’s important to strike the right balance between ensuring  your company receives the long-term benefits of retaining your employees and ensuring the vesting period feels attainable.

Particularly in today’s job environment where job-hopping is increasingly common, talent may be hesitant to rely on equity compensation if they believe there’s too high of a risk they won’t reach the end of the vesting period.

Risk: Short-term compensation needs

Share vesting is an attractive tool as a supplementary piece to a compensation package, but the promise of long-term financial gain doesn’t replace the need for tangible compensation in the short term.

Again, balance is key—while share vesting can bolster an offer where the salary or other tangible benefits are below-market, few employees are in a position to accept equity—and especially shares that are subject to vesting—if the rest of the compensation package doesn’t meet their short-term financial needs.

Bottom line

When used properly, share vesting can serve as a vehicle to minimise cash outflow, grow your business, and keep your employees happy and productive. But, as with most considerations in the startup world, it must be done strategically to be able to maximize the benefits and minimize the risks.

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