Share Options in Early Stage Tech – Vesting or Reverse Vesting: Which Way Is Best?

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“Vesting” is the term used when someone is entitled to an increasing number of shares over time – usually via stock options.

For example, an option holder can be granted options on shares on a progressive basis over a period of three to five years. The option holder is often an employee, so this mechanism motivates the option holder to stay with the company for the long term. In some cases, options are used to increase an employee’s salary if the company is unable to pay the market rate for that employee’s salary.

The vesting schedule can be constructed to have a “slope,” meaning that if the option holder leaves the company before the initial vesting period has expired, the option holder will not be entitled to any shares.

Options can be worded to contain more complex provisions, such as making vesting subject to performance criteria (by the company, team, or designated employee) or specific events (eg, a sale or listing of the company).

Equity provisions are most suitable for motivating employees. There are many tax-efficient option schemes (for example, enterprise management incentive schemes) that can be used by many early-stage technology companies.

reverse accrual

As the name suggests, “reverse vesting” is the opposite of vesting where shares are issued up front. If a shareholder leaves the company before the end of the vesting period, the shareholder will have to sell his unvested shares (either back to the company, if the company is able to meet the buyback rules under company law, or to other shareholders, or an employee trust). The reverse vesting period usually ranges from three to five years.

Reverse vesting schedules are best suited for founder shareholders where the founders will actually hold shares and will not want to give them up (for voting and tax reasons). However, a reverse vesting schedule will provide a useful mechanism for new investors to help ensure that the founders stay with the company for a certain period of time.

The reverse vesting schedule will also provide co-founders with assurance of each co-founder’s commitment to the company. As with forward vesting schedules, additional criteria (eg, performance objectives) may be added as part of the reverse vesting mechanism.

conclusion

Both vesting and reverse vesting are useful mechanisms but they differ from each other and care should be taken to ensure that the most appropriate mechanism is used.

*This article is provided by Business Leader


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