Statistics show the first couple of years a startup is active are key to its success. After all, it is in this time the company’s structure, culture and investment schemes are set up. Share Vesting is a means to further invest time wisely and ensure the business’ interests are safeguarded.
How can you make the most of this time?
Employee Share Vesting Explained
Share vesting means an employee (or founder) can be rewarded for their work by gaining company shares over time. In this process, an employee can either acquire rights over stock incentives or contributions made to his pension plan. This means that if the company grows the shares you attained will increase in value over time. Furthermore, you are entitled to those shares even when you are fired or quit.
Typically, shares are vested over a four year period. This means that if the company owes an employee 400 shares they will distribute 100 shares to that employee per year. Less common is the process of performance vesting, where an employee is given shares based on hitting certain targets.
The terms and details of how shares are vested are known as the Terms of Vesting and these are included in your Shareholders agreement (if it is a founder receiving the shares) or Employment Contract (if it is the employee receiving the shares).
A cliff clause describes a period where no shares are being allotted. This clause describes the minimum period of time that must pass before your shares begin to vest.
Why is this done?
A cliff period is crucial in mitigating risk in the initial stages of a company. The initial stages of a startup are usually periods of excitement, but it is possible that employees (or founders) may leave after a short time when they do not immediately see the company perform. A share vesting cliff basically allows you to trial a hire without immediately committing to equity. This allows early leavers to not benefit with any of the company shares.
Therefore, when allotting those 400 shares if you leave within the first year you are not entitled to any shares as you are in the cliff stage.
What About Reverse Vesting?
Reverse vesting works in the opposite manner to traditional vesting, i.e. the employee receives his shares upfront. If they leave, these shares can be repurchased by the company at a set amount per year. This process is done through a Restricted Stock Purchase Agreement. This can protect the business by forcing someone who leaves with a large amount of stock to return it to the company.
UK Law – 2016 EES Limitations:
In 2016 a law was introduced to limit the capital gains tax lifetime limit on the employee shareholder status. This meant that the limit of capital gains tax an employee can make on shares acquired in a shareholder agreement in £100,000. This means that if you make more than £100,000 of gains on employee shareholder shares you will be charged Capital gains tax on the money made above that threshold.
However, the ‘gain’ that you make is the profit made when you sell those shares (that will have increased in value). Although the tax is paid over £100,000 the UK only charges 18% Capital Gains Tax, making it still a profitable investment in comparison to other EU countries.
How Share Vesting Can Help Your Startup Grow:
1. Performance Incentives
By giving employee rights to assets over time, which are to increase in value, there is an incentive for him to perform well. This is why they can be an essential part of a startup package where wages tend to be lower.
2. Long Term Employees
The potential of future rewards, furthered by a cliff clause provides an employee with a reason to stay with the company long-term. With share vesting, the odds are that an employee staying long term will protect you from a future bad hire and it enables you to do this without paying out a high salary.
The Facebook Success Story
A man who took this gamble and won big time was mural painter David Choe. The original Facebook headquarters in Palo Alto were painted by him when Facebook was still a young startup. Rather than taking several thousand dollars as pay he bought some shares of Facebook. In 2012, on the eve of Facebook’s initial public offering (IPO), his shares were valued at about $200 million.
Need your Vesting Terms prepared? Book a call with our legal team and we’ll get your questions answered.