May 24 2007 by Jason

Equity Compensation Terms

As part of your offer, there will likely be an equity component (if there isn’t, your first question after receiving the offer should be “so – what equity are you offering me as part of this package?”) The equity component will either be a grant of stock options or restricted stock – both with some sort of vesting component. If you’ve been employed by a startup before, you are probably aware of the concept of vesting; if not, take a look at our description of vesting in our Term Sheet series.

The standard vesting terms for a venture-backed company are typically a four-year vest with a one year cliff. For example, let’s assume you are granted an option for 10,000 shares of stock as part of your compensation package. A standard vesting plan would have you vest 25% of your options (2,500 shares) after one year (“the cliff”) and the other 7,500 monthly over the next 36 months (or 208 shares / month.) The vesting increment is usually either monthly or quarterly after the cliff period ends.

Note that “restricted stock,” while different, essentially works the same way. With restricted stock, the holder actually owns the stock, but the company has a right to repurchase should they no longer work at the company. The terms around this repurchase right “expires over time” – you can think of it as the same as vesting.

People ask about what types of acceleration we see in vesting arrangements. There are several common ones:

1. Acceleration based on prior performance: Many times a VC invests in a company whereby the founders own stock outright that prior to the VC financing is not subject to vesting. It is a pretty standard practice that the VCs will want to subject these equity holdings to a vesting schedule to incentivize the founders to stay around post financing. Normally, however a founder who has worked hard for a year to get the business off the ground will usually get a year of vesting credit. The actual amount varies – don’t expect to necessarily get vesting credit back to the day you originally thought of the idea while working at BigCo.

2. Acceleration based on termination: Often, founders and non-founder executives will negotiate a clause into their employment agreements that if they are fired without cause, their option vesting accelerates a year or so.

3. Acceleration based on an acquisition and termination: Commonly called “double trigger acceleration” this acceleration takes places when a company is bought and post acquisition, the acquirer terminates the employee within some period of time (usually within one year of the acquisition). The first “trigger” is the acquisition; the second “trigger” is the termination. It’s pretty standard practice that double trigger acceleration exists in company-wide stock option plans. Therefore, all employees at the company who are fired after an acquisition and within some time period enjoy the benefit of their options accelerating. The amount of the acceleration ranges broadly from a year to full acceleration.

4. Acceleration based on non-assumption of plan: One of common term in equity plans is the clause that accelerates all options under the plan if an acquirer doesn’t assume the option plan upon buying the company.

The other major term one see recently is the concept of a “drag along.” This is a relatively new term that’s come about in the past five years. It subjects stock holdings to a drag along, or voting proxy, whereby if the holder is no longer with the company, their shares are automatically voted (drug along, essentially) by the majority of the shareholders that are still with the company. This term became popular to ward off disgruntled shareholders who were no longer with the company.