4 Year Vest vs Yearly Option Award

Written by
Ross Andrewsarrow icon

4 Year Vest vs Yearly Option Award

Written by
Ross Andrews

4 yrs, the standard vesting schedule for startup employees to be able to capture the full value of their stock options. Typically those options are provided to you in a grant when you first start the job and they are given a “strike” price which is the dollar value, per share, that you have to pay in order to excise those shares once you have vested them. That strike price is typically set based on the valuation and stage of the company given that the price per share when employee 1 joins a startup is typically different than when employee 100 or 1000 joins.

These vesting schedules typically include a 1-year clip, meaning you vest zero options for the first 12 months, and then on your 1 year work anniversary, 1/4 of the options in your grant fully vest, and then the remaining 3/4 continue to vest, 1/48th at a time each month for the next 3 years. The benefit being, if the startup starts to increase in valuation, your strike price 2–3–4 years in remains the same, so if your strike price was $5 and the company raised in year three of your vest as a $25/share valuation, then your option instantly net you a $20 profit on excise.

Uber, Lyft, and Stripe have been in the news recently as they announced that they are changing from a 4-year option vesting plan to a 1 yr stock option award package. I have one word, caution. This is a slippery slope that can be driven by one thing, greed.

By going to 1-year option awards, these three companies will claim that they are enabling employees more flexibility in that they can work for a year or two at one company, earn some options, then go work somewhere else and earn options there as well. I find this argument self-serving given the fact that if an employee goes to say Stripe and works for 2 years on an option grant they will have vested 50% of their shares. If they feel as though they have earned enough and are ready for a new challenge, they can take half their options and leave for a job at say Uber, ready to earn a new set of options on a new grant.

To illustrate the impact of this to a startup employee that joins a hyper-growth startup that goes from a $50M valuation to $1B over the course of 4 years:

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If you do stay the full 4 years this new plan would cost you $700,000, and btw, that $700,000 goes back to the company and the hands of the founders and investors. Some will point out that the value of the option on the bottom is $200,000 versus $100,000 on the traditional 4-year vest, but the startup is using the valuation arbitrage from year one to year 4 to actually offer you less and less of the company at higher valuations over time, so the notional value of the shares is more in year 4 yes, but for an employee, just like a founder or investor, the financial benefit of options in a startup is the valuation multiplier which you are now getting diluted out of.

Would a VC fund take incremental equity on each dollar the startup spends over time and the value of that equity is dynamic and dilutes over time as the valuation rises? Of course not, so why should you for the hard work you put in?

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