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Bootstrapper Equity: Why Time-Based Vesting is a Waste of Time

Any startup attorney or experienced entrepreneur will prudently recommend a time-based vesting schedule for early-stage employees who accept equity in lieu of cash compensation. A vesting schedule prevents a slacker employee from walking away from your company with a chunk of equity when they quit or fail to perform. In my opinion, such agreements are a waste of time and money because they are simply a Band-Aid over a much larger, gaping wound that is the underlying equity agreement.

A vesting schedule implies that a fixed number of shares were allocated to an individual before any actual work was completed. Once equity is doled out, the owner if the shares can simply walk away and keep the shares. To mitigate this risk, the vesting schedule forces the employee to stick around for specific time intervals before they can keep the shares. For instance, they might get to keep 20% of their shares at the end of each year. At the end of five years they own 100% and are “fully vested.”

Of course, there is nothing to prevent the employee from quitting the day after her shares vest, nor is there anything preventing the employer from firing the employee the day before her shares vest. I’ve seen both scenarios and neither are pretty.

To further mitigate the damage caused by this sort of thing you have founder’s share agreements and buyback agreements and employment agreements and it goes on and on. Lots of money spent on lawyers instead of on marketing. Not a great way to start a company.

The fundamental, underlying issue is the act of doling out a fixed chunk of equity in the first place. Fixed equity splits are akin to paying someone their entire salary on day one. Giving someone a lump-sum salary payment in advance of work getting done sounds stupid because it is stupid. But, so is giving them a fixed chunk of equity. It’s the same thing.

The Slicing Pie model does not use time-based vesting because slices in the pie are only allocated when actual work is performed. This prevents the possibility that someone will have un-deserved shares. Additionally, the Slicing Pie recovery framework dictates the disposition of the shares when someone leaves the company. Consequences are imposed on the party that caused the separation. Getting fired for performance reasons, for instance, is different than being fired for no reason or being laid off.

If you are using or have been offered a time-based vesting program you are dealing with an equity program that is fundamentally flawed. It’s such a common mistake that most people don’t realize they are making it. Use the Slicing Pie model to ensure that everyone gets what they deserve and everyone has the proper protection.

  • poshest

    What was that about “Lots of money spent on lawyers instead of on marketing.”? From your book: “A Grund Fund-style vesting schedule is considerably more complicated than a traditional vesting schedule”

    • Slicing Pie is a formula. The vesting agreement should include a reference to the formula. It should not be more complicated.

      -Mike

  • poshest

    There’s one place in your model that I think something like “vesting” could work. That is in the case of “resignation without cause”.

    In your book, you say grunts get 0% of the pie they earned for the time they put in.

    What if they put in 3 years’ work and made some significant achievements, should they still get 0%? I think that’s unfair.

    You might say that after 3 years the company should have formalised the agreement and allocated shares or options etc, but I think at least in theory, there’s a case for a vesting schedule here.

    So these cases are unchanged from your book:
    – termination with cause gets 0% of “time” pie.
    – both resignation with cause and termination without cause gets 100% of “time” pie.

    BUT resignation without cause could allow the employee to leave with…
    – 4 years’ service: 100% of “time” pie

    As I’ve suggested it, 1/4 of their pie does NOT vest after 1 year, because that encourages that perverse result you mentioned of employees quitting after 1 year + 1 day.

    • You’re right. Sometimes,a loyal employee works hard, but has to resign to make ends meet. It’s true they may be leaving the company in the lurch, but taking back their equity may not seem like the right thing to do. In these cases, I recommend the person
      reduce their hours, but stay involved on a part-time basis. This will allow them to keep their slices and allow the company to continue to benefit from their expertise.

      You could also adopt a rule, like yours, which states that any slices over a certain number of months stay in place in the event of resignation with no good reason. This will give good employees who have to leave an option to leave without losing everything. I think it’s important to have some consequences, but I understand that people’s personal lives may not always stay compatible with working with a startup.

      I do not recommend doing this for people who are fired for good
      reason.