When startups issue stock to founders, they usually subject some or all of the shares to vesting. This means that even though the founders own their shares, the corporation can repurchase some shares if the founder ever stops providing services to the corporation.1 The number of shares the corporation can repurchase is limited to the number of shares that have not yet vested.
Vesting is also used for stock or options issued to employees and consultants. Learn more in our article about equity compensation.
When common stock is subject to vesting, it is referred to as restricted stock by startup attorneys. Restricted stock typically vests over time on a schedule known as a vesting schedule. The date when vesting begins is known as the vesting commencement date.
The most popular vesting schedule, by far, is frequently referred to as 4-year vesting with a 1-year cliff. Under this vesting schedule, 1/4th of the shares subject to vesting will vest on the 1-year anniversary of the vesting commencement date (this is the 1-year cliff). After that, 1/48th of the total shares originally subject to vesting will vest every month.2 By the end of 4 years, all of the stock will have vested.
The second most popular vesting schedule is 4-year straight line vesting, which means that 1/48th of the total shares originally subject to vesting will vest every month. 4-year straight line vesting is the same thing as having 4-year vesting with a 1-month cliff.
The vesting commencement date is commonly set to the date the shares are issued to the founder. If a founder put substantial work into the startup prior to the stock issuance, it is not uncommon for the startup to give the founder some vesting credit. This refers to setting the vesting commencement date to an earlier date - often the date on which the founder started working on the startup full-time.
Vesting protects founders, investors, and employees. Consider two co-founders that have just begun work on a startup, and have decided to split the equity evenly. If one co-founder leaves after just a week and his or her stock is not subject to vesting, the remaining co-founder and other employees could go on working for years and still have the same level of ownership as the departed co-founder. By subjecting stock to vesting, startups avoid this kind of scenario.
For Solo Founders
If a solo founder does not already have vesting in place, investors will often require that a vesting schedule be put in place. Consequently, it is common for solo founders to impose standard vesting on their stock at formation, in order to reduce their chances of ending up with less favorable vesting terms.
For example, imagine a solo founder begins full-time work on their startup and does not subject their shares to vesting. Suppose that after months or years of work, the founder looks to raise money from an angel investor. The angel investor, seeing that the founder's shares are not subject to vesting, will probably require the founder to subject their shares to vesting, and may only allow for partial vesting credit (or none at all). Had the founder's shares been already subject to a normal vesting schedule, the investor might not have raised the topic at all.