For people holding equity that has not yet fully vested: Does the vesting status affect your thinking about when you might leave your company?
For investors or CEOs: Are you worried that a key employee will leave your company when his or her equity vests?
Some background: My Founder Discount paper examined how founders’ “psychological handcuffs” affect (negatively) the amount of compensation founders want and/or can demand from their boards. Because these psychological handcuffs tie them more tightly to their companies, founders are much less likely to leave if they are being under-compensated. Therefore, founders are paid significantly less than non-founders, especially during the early years of venture growth, when founders’ psychological handcuffs are strongest.
In a new working paper that follows up on the Founder Discount paper, I examine whether boards use “golden handcuffs” to tie executives to their ventures. The specific form of golden handcuffs I examine are the vesting terms for each executive’s equity, most centrally the number of years over which an executive’s equity (received at the time of hire or when vesting terms are introduced into the company) vests.
Investors often impose vesting terms as a condition of their investments. In a post that takes a “Term Sheet View” of vesting, Brad Feld, a VC at Mobius Venture Capital, highlights the importance of vesting terms: “[T]he impact of this term is crucial for all founders of an early stage company … it can have profound and unexpected implications … many entrepreneurs view vesting as a way for VCs to ‘control them, their involvement, and their ownership in a company.’”
A couple of years ago, I decided to get a more systematic view of the drivers of vesting, in particular examining how it is used ex ante to affect executive retention. The table below summarizes the results from initial analyses of data I collected via my 2005 Entrepreneurship and Compensation survey. The analyses included 1163 executives (VP level and above) from 225 private IT companies.
Also of possible interest are other factors that were not statistically significant:
- Equity % at time of hiring
- Position differences (CEO vs. CFO vs. Pres/COO vs. below-C-level)
- Outsider vs. insider control of board
- Educational degrees
Questions: Do any of the results above conflict with your experiences? What other factors should have a strong effect on vesting terms?
In my next post, I’ll give some of my interpretations of these results.
As always with these early-stage analyses, love to have you post your thoughts on these issues!
We often use a concept of “partial credit for time served” when deciding on how much vesting is behind an entrepreneur and how much is out front. Our desire always is to have as much vesting out in front of the team as possible and competitive dynamics on a deal sometimes require one to give partial credit. Often founders are the most committed to a company and desire for the VC to keep the team on the longest clock possible. We’ve gone to five year vesting in some of our companies, especially when they are early stage as 5-7 years is the expected time it takes to build these and it delays when you have to start an evergreen program. If there were a rule of thumb here, it is roughly 1/2 credit for time served, so if a founder has been at it for two years and we invest, we’ll often give them 1 year vested and have 3 or 4 years of vesting out front. We typically treat the entire team the same on this front, with new execs who have started recently not getting the benefit of the founder being there for two years. Anything less than three years of vesting in front of anyone on the team on an early stage deal starts to get very risky. I’ve never done a 1 year vest thus far.Acceleration clauses we try to keep as standard as possible as well. We make great returns usually only on deals that go public, so we have little incentive to encourage quicker exits. Those acceleration clauses can always be negotiated in on a company you think needs to get acquired, but at the beginning we prefer for everyone to have a long term focus like we do on the companies. Occasionally we do have acceleration clauses, usually they are for hired ceos as a requirement in the negotiation. Typical there is 1/2 of the unvested shares on a double trigger (change of control and effective termination).
Vesting is a big issue because the economics of being a startup employee.Let’s say that an employee has been with the company long enough to fully vest her stock. At that point, it is economically irrational for that person to stay, unless she is absolutely critical to the business.If the business can survive without her, she is better off leaving and joining another company. The best her current company can do is to grant her more stock. The problem is that such stock is worth less in marginal utility. If the company achieves a liquidity event, it is unlikely that the additional stock will have a major impact on her life.On the other hand, joining another company has the benefit of providing an additional slug of diversification.
My experience with our portfolio companies has been much the same as Tim lays out. The only difference would be on acceleration of shares. In the case where an individual is brought in as CEO 3-4 years into a company’s existence, we are often stuck with giving him/her full vesting on the unvested shares on a double trigger. Reason being that a strong CEO, who has been through the fire before, knows the game and will make this a centerpiece of negotiation. For us, the full vesting on a change of control has not really caused us issues (yet?).I find Chris’ comment on “Economic Rationality” interesting. My experience has been that in the case of a founder, while it may be economically irrational for the person to stay once fully vested, most do not want to leave. Many founders are motivated by much more then unvested shares. For them, the company is their life’s work. And just as they were “present at creation”, they would also like to be “present at culmination”.
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