Vesting

Vesting decides when someone actually gets to keep equity in a company. Without it, shares or options promised at the start belong to the holder immediately. With it, the entitlement builds up over an agreed period, and anyone who leaves early keeps only the portion earned by that point. The term shows up twice in a funding round: once for the employee pool, once for the founders' own shareholdings.

How vesting is calculated

Three numbers do the work. The vesting period sets the total length of time over which the entitlement builds. The cliff is a waiting period at the start, during which nothing is earned; once it passes, the amount accrued so far lands in one step. The accrual interval governs how the remainder builds up after that, usually month by month.

Four years with a one-year cliff is the pattern most often seen in venture deals. It is a market convention rather than a rule, and it shifts with the situation. Under that pattern a quarter of the grant is earned after twelve months, a forty-eighth is added every month afterwards, and the whole grant is earned after forty-eight months. Someone leaving in month ten keeps nothing, while someone leaving after two years keeps half.

Two further settings carry weight. The start date is usually the first working day rather than the date of the signed grant, which can move the cliff by months. Acceleration provides that unvested equity vests early on a sale of the company, either on the change of control itself or only if the person also loses their role.

Founder vesting and why investors insist on it

For founders the mechanism runs in reverse. Their shares already sit in the shareholder register, so nothing needs to be granted. What the contract regulates is the claw-back instead: a founder who leaves early hands back the portion not yet earned. That is why the arrangement is called reverse vesting. Time does not add shares here, it shrinks the company's right to take them away.

The reasoning is straightforward. A financing round mostly pays for work still to be done, and that work depends on the people who signed up to do it. Without vesting, a founder could take the money, leave soon afterwards and keep a full stake while everyone else carried on. The same rule protects the founders from each other, because it applies to all of them equally.

German practice differs from the Anglo-American default at this point. In a GmbH the arrangement sits in the articles of association or a shareholders' agreement, not in an employment contract, and it usually takes the form of a compulsory redemption of the shares, which the articles of association have to permit, or a duty to transfer them against compensation. Transferring GmbH shares, and even the agreement to transfer them, has to be notarised, so that route costs time and notary fees, while a redemption takes effect by shareholders' resolution instead. There is no German counterpart to the US restricted stock purchase agreement or to the Section 83(b) election, since the tax treatment follows German rules.

Good leaver and bad leaver

Contracts distinguish between reasons for leaving. A good leaver typically departs for reasons outside their control, such as illness or termination by the company without cause. A bad leaver resigns, or is dismissed for cause. The consequences diverge sharply: a good leaver normally keeps the vested portion, while the unvested part goes back at nominal value or original cost; a bad leaver may forfeit the vested shares as well and be paid nominal value for them.

Because the label carries most of the money, the definitions deserve closer reading than the headings. The contested cases sit in between, for instance a mutually agreed exit or the closure of one business line. German courts have held severe bad leaver clauses invalid in individual cases where compensation stayed far below value for an open-ended period, which is one reason local drafting is more cautious than a US template. This entry sets out the building blocks; the drafting itself belongs with a qualified lawyer.

A further German specificity concerns employees. Real share options are rare in a GmbH, so companies issue virtual shares (VSOP), a purely contractual promise of a cash payment when the company is sold. Vesting works the same way there, but no share changes hands, and the payout is normally taxed as employment income rather than as a capital gain, though the treatment depends on the individual arrangement and on advice from a tax adviser.

Related terms

• ESOP: the employee pool whose grants vest on these terms.
• Term sheet: where the period, the cliff and the leaver rules are first agreed.
• Liquidation preference: decides what vested equity is actually worth at exit.
• Due diligence: where the vesting status of every holder is checked.