Equity allocation to founders and employees is one of the most critical aspects of managing a startup. At an early stage in a company’s life, it’s essential to establish a mechanism that balances rewarding key partners with protecting the long-term interests of the company and its investors. The two main tools for properly managing equity allocation are Vesting and Reverse Vesting.
Although these terms are sometimes translated into Hebrew, it’s important to note that in the startup and venture capital industry, they are almost always used in English. For that reason, we’ll refer to them throughout this article as Vesting and Reverse Vesting.
These mechanisms exist to address a common risk: a founder or key team member might leave earlier than expected or stop contributing meaningfully to the company. Without the proper structure, this could leave someone who is no longer active holding a significant portion of the company’s equity — potentially hindering future growth or fundraising.
What is Regular Vesting?
Vesting is a process in which a founder or employee earns rights to their shares or stock options gradually over time. That means they don’t receive all of their equity upfront, but instead “earn” it based on a predetermined schedule and their continued contribution to the company.
Typically, the vesting period lasts 3–4 years and includes a one-year cliff. For example, if the vesting period is 4 years, then after 12 months of work (the cliff), the person receives 25% of their promised shares. The remaining shares vest monthly — for instance, 1/48 each month thereafter.
Numerical example: A founder is promised 10% of the company. After the first year (cliff), they receive 2.5%, and then an additional ~0.2083% vests each month (2.5% per year).
What is Reverse Vesting?
Reverse Vesting refers to a situation where the founder holds shares from day one, but the company retains the right to buy them back if the founder leaves before completing a predefined commitment period. This structure also typically spans 3–4 years and includes a one-year cliff.
Each month, a portion of the shares is released from the company’s repurchase rights. The longer the founder stays with the company, the more of their shares become fully owned and protected from buyback.
Numerical example: Let’s assume a 4-year reverse vesting schedule. A founder receives 20% of the shares on day one. However, if they leave within the first year, the company has the right to repurchase all 20% at a nominal price. After one year, 25% of the shares (i.e., 5% of the company) are released, and about 0.416% more are released each subsequent month.
Need Help Drafting a Vesting Agreement? Talk to Us.
So when should you choose Vesting, and when is Reverse Vesting the better fit? Each approach is suitable for different scenarios and should be selected according to the unique structure of your company and founding team. The decision should always be made carefully and strategically.
At Danoy, we specialize in supporting startups and tech companies. We’d be happy to help you define and draft intelligent Vesting mechanisms that support your growth and long-term success.