The “Summary of Vesting Data” post presented the overall patterns in my vesting data and delved into the founder vs. non-founder differences. My “Early Analyses” post listed both the most significant drivers from my regression analyses of vesting periods and some of the not-significant factors. The core table from that post is reproduced here:
This post presents my initial interpretations (and those of the 2 entrepreneurs and the 2 VCs who contributed their insights in response to those posts), along with follow-up questions in italics below. As always, love to get your input on all of this!
Significant regression result: Founders vs. Non-founders
Not significant: CEOs vs. Other C-level executives vs. VPs
In his comment, Chris stated that it is “economically irrational” to stay at a company after your shares have fully vested, highlighting the critical retention issues involved in vesting. Scotty countered that founders in particular are motivated by strong non-economic factors and usually want to stay at their companies even after they have fully vested. (Presumably, then, Chris’ point applies much more to non-founders than to founders.) Tim also highlighted the higher level of “founder commitment” as a factor in vesting/retention decisions.
These latter arguments are consistent with my observations elsewhere about founder vs. non-founder differences. In particular, as described in the Founder Discount paper (summary-postings here and here), founders have stronger psychological handcuffs tying them to the companies they founded, so when it comes to vesting, boards should view founders as posing lower “retention risk” than non-founders. In contrast, the weaker an executive’s psychological handcuffs (i.e., the higher the retention risk), the stronger should be the golden handcuffs used by boards, as suggested by the first result listed in the table.
Furthermore, much as founders’ psychological handcuffs weaken over time (in “Founder Discount,” this leads to a reduction in the compensation gap between founders and non-founders), so too the vesting gap between founders and non-founders shrinks (as per the second row in the early-analyses table) — also supporting the concept of a substitution effect between psychological handcuffs and golden handcuffs.
In short, golden handcuffs seem to be used (at least in part) to make up for a lack of psychological handcuffs.
Other reasons for founder vs. non-founder differences may be related to negotiating dynamics.
For instance, reaching back to Brad Feld’s note on vesting, he states: “Often, founders will get somewhat different vesting provisions than the balance of the employee base,” which is confirmed by the results above. The reason Brad gives for why this is true is that the founders “want to get some credit for existing time served.” On its own, this reason does not seem strong enough to produce such a big gap between founders and non-founders; although I agree that founders want that credit for past contributions, forward-looking VCs seem to be using vesting largely to lock in people for the future rather than to reward the past. However, Tim adds a key second element that strengthens Brad’s assertion about a founder’s ability to get this “partial credit for time served”: that founders who are able to negotiate better vesting terms are often able to establish a “competitive dynamic” when raising a round (presumably, are able to generate interest from multiple VCs and thus gain negotiating power).
In a related vein, I have observed founders who tried to pre-emptively impose (relatively favorable) vesting terms on themselves in an effort to have more negotiating leverage over vesting terms when they raise outside money. In this sense, they are hoping that early self-imposition of vesting terms will lead to lower years of vesting later.
Furthermore, some founders (for example, Ockham’s founders) also reason that it is in their own interest to have their co-founders locked in for a period of time. In this sense, the self-imposition of vesting terms is another way to accomplish a dynamic equity-split agreement, whereby founders who leave have to forfeit equity.
In an interesting linkage to Founder-CEO succession, an anonymous poster suggested that in his company, the founder was able to negotiate better vesting terms for himself/herself as “the quid pro quo to the VCs saying ‘we may have to replace you’ to the founder.” However, the same poster (and Scotty) also suggested a counter-effect, wherein non-founding hires (e.g., a bridge CEO) are able to negotiate shorter vesting periods by making vesting “a centerpiece of negotiation” before they are hired. However, despite this counter-effect, the broad pattern shows that founders receive much shorter vesting terms than do non-founders. Also as shown above, after controlling for the founder effects, CEOs do not seem to have any more leverage over vesting terms than do non-CEOs.
What other reasons are there for the founder-nonfounder vesting gap, and for the non-gap between CEOs and non-CEOs?
Significant: Years of prior experience (inverted-U relationship)
Not significant: Educational background/degrees
There is an inverted-U relationship between the executive’s years of prior experience and the years of vesting. Executives with 15 years of prior experience have the most years of vesting, while executives with a lot more or a lot less than 15 years have shorter vesting periods. At the same time, educational background (having a PhD, MBA, etc.) has no effect, either positive or negative.
Why are very experienced executives (i.e., those with much more than 15 years of experience) not locked in as much as those with a mid-range of experience?
Two more-specific forms of prior experience are prior experience in the same industry and prior experience in private companies. Have those two factors (or the lack of them) affected vesting terms for you or in your companies?
Significant Tradeoff #1: Years of vesting vs. Accelerated vesting at change in control
Significant Tradeoff #2: Years of vesting vs. Salary
Not significant: Years of vesting vs. Equity % at time of hire
Executives who get accelerated vesting if the company changes control (usually, is acquired) do so at the expense of being handcuffed for longer if the company doesn’t change control.
Have you seen any specific instances of this?
Executives who receive more salary are handcuffed for longer. This may either be part of a hiring negotiation (“I’ll let you lock me in for 4 years instead of 3 if you’ll give me $50K more in salary”) or just be because executives who are worth more compensation (even after controlling for differences in years of experience and education) are worth locking in for more years.
Interestingly, as shown in the non-results list, there is no comparable tradeoff between vesting years and equity %.
Any thoughts on why the amount of equity is not traded off against the period over which it vests?
Significant: Professional CEO (longer vesting terms for executive team)
Not significant: Outsider vs. Insider control of board
When the company has a “professional CEO” (as opposed to a founder-CEO), the executive team averages more years of vesting.
Is this because the professional-CEO demands that the team have longer vesting terms, to a greater extent than a founder-CEO would?
Although the presence of a professional-CEO seems to affect vesting terms for the rest of the team, the existence of an outsider-controlled board does not.
Why would the professional CEO have such a stronger effect on this than does an outsider-controlled board?
Significant: Expected exit is IPO (longer vesting)
Significant: Expected exit is acquisition (shorter vesting)
I am hesitant to attach much solidity to the IPO/acquisition effects here (because there are relatively few companies in each of those buckets), but they have such large effects that they’re worth noting. The most interesting thing is the opposite effect of each of these exit options: if you expect to go public, it’s more important than usual to have you locked in, and if you expect to be acquired (and may not be retained by the acquirer anyway?), it’s less important than usual to have you locked in.
Final Note: Time-based vs. Milestone-based Vesting
Tim highlights how VCs often try to tie vesting terms to their best guess as to how long it will take for the venture to achieve a key milestone: “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…” This brings me back to a recurring question about the preponderance of time-based vesting (essentially, “paying for a pulse”) rather than tying vesting directly to the accomplishment of concrete milestones:
What are the barriers to tying vesting directly to the achievement of those milestones, rather than trying to guess how long it will take to achieve them (with all the problems inherent in that) and then tying vesting to that amount of time?
If you have seen milestone-based vesting instead of time-based, what kinds of milestones were used, in what ways?
Noam-I would add another nuance to the point on vesting differences between founders and non-founders. Many company founders have a sense of what they expect their absolute percentage holding of the company to be at exit- for example, an engineer co-founder of a company who becomes CTO and may have started with 15% of the equity can reasonably expect to own about 5% by the time of exit, assuming normal dilution from future financing rounds. Presumably,he would be on a normal 48 month vesting program. As you know, the average time to exit for a venture-backed company is now 6 years. To the extent that the founder feels his equity is below the original exit target percentage and he is fully vested after 48 months, the board may have to make new grants for retention purposes during this “stub” period between being fully vested and a liwuidity event.The psychological element that you mention is very powerful. To note the obvious- if a founder feels generally well treated and, most importantly, feels that he or she continues to add value to the company, that person is more likely to stay and be around for the victory lap. For non-founders, particularly in Silicon Valley, the butterfly syndrome is more prevalent- but you can burn up your reputation pretty quickly and make yourself a margnial candidate for new positions if you show a pattern of 2-3 year job hops in more than 2 venture-backed companies.I am reminded of one VP Marketing at a company who played this game and left the playing field when we had a hiccup at the company- now the company is doing very well, and this person won’t find a welcome mat at any other ventures that our board is involved with.
Some very interesting findings. I was particularly intrigued by the parabolic relationship between experience and vesting. It would seem that as an executive develops more human capital and a denser social network, the need to retain him/her would increase and result in higher vesting. At the same time, beyond a certain point, I could see the defection risk and opportunity decrease. This could be because relative productivity begins to decline, and the expected wage/output starts to be less favorable. There’s also the added factor of the exec seeming “less relevant” technologically and perceived as having a lower risk tolerance psychologically. Does this corroborate with what anyone else has seen?