I believe vesting is the most important element of corporate structure. It is essential to ensuring that both entrepreneurs and investors are treated fairly and equitably. Vesting has incredibly powerful effects on the group psychology, culture and corporate performance. I have seen many companies literally fail due to flaws in their vesting.
Widespread employee ownership is still a relatively new concept. Even as recently as the 1980’s, there was still debate on the degree to which employee equity ownership affected corporate performance.
Today, it is widely accepted in North America that companies with broad employee ownership create larger increases in shareholder value.
After a couple of decades of experience, and a few good analytical studies, there is now a broad consensus on the range of equity that is reasonable for a new CEO, or other senior employee, to expect when joining a company.
Even though there is now reasonable agreement on the ideal magnitudes of equity ownership, there is still discussion on the optimum vesting formula.
In my opinion, the most fair and equitable structure, and the one that maximizes the alignment between the founders and the investors, is to vest:
- 50% of the shares daily over a three year period; and
- The other 50% when there is a sale of the Company.
- All vesting for senior employees accelerates on a sale of the Company.
The rest of this post describes the evolution of vesting and the elements of contracts and psychology that make this formula optimum.