vesting, yc-how-to-start-a-startupWhats the difference between forward vesting and pyramid vesting?
Which one should an early startups and a late stage startups use and why?
This question is based on “How to Start a Startup” - Lecture 20: Later-Stage Advice, by Sam Altman; following is the excerpted from the video presentation:
One thing that I think is really important when it comes to HR is equity. Most people get this right now for the early employees. They give a lot of equity. But you should continue to give a lot of equity all the way through. And this is one place that you investors will always give you bad advice. I think - not YC. But all other investors give bad advice here. Most do. You should be giving out a lot of equity to your employees. Now this dilutes everyone.
Right? This dilutes you as the founder and the investors equally. For some reason founder usually understand this as good. Investors are very short-sighted and don’t want to dilute themselves so they’ll like fight you over every equity grant. But, we’ve seen a lot of data at YC now and the most successful companies - and the ones where the investors do the best - end up given a lot of stock out to employees. Year after year… After year.
So I tell founders, “You should think about for the next ten years you’re going to be given out 3- 5 percent of the company every year ‘cause you just get bigger and bigger. So the individual grants gets smaller but in actuality it’s a lot of stock. This is really important to do if you value your people you should be doing this. Specifically, you need to do this with refresher grants. And you should get a plan in place for this early. You never want an employee in a place where they vested 3 out of their four years in stock and they start thinking about leaving. So you should ALWAYS stay in front of peoples vesting schedules. And you know how they plan early where you have refresher grants in place.
There are a lot of new structures that people have been using here. I personally like six year big grants - but six years of vesting. ‘Cause I think these companies take a while to build. There’s pyramid vesting where you back weight someone’s grant. In year four they get a lot more of the vesting than year one. There’s a concept - different names for it, but something like continuous forward vesting where people’s grants are automatically re-upped. Every year. At the same number of share. Whatever you decide, get an option management system in place at about this point. The normal way people do this is just someone keeps an Excel spreadsheet. I have seen mistakes that have cost employees or companies tens of millions of dollars because they didn’t get this right.There’s really good option management systems or software and you should get those in place around this point.
Forward Vesting
The stock options/shares you grant are given in increments over a period of time. Typical arrangement for an early stage startup may see a 4 year vesting period with 1 year cliff. During the first year of cliff none of the stock options/shares are granted. This is done to prevent someone who hasn't worked for a minimum of one year from getting any equity. After the cliff the stock may vest monthly/yearly depending on a pre arranged schedule.
Pyramid Vesting
In this case you give more stock options/shares the longer the person stays in the company. So for the typical 4 year vesting period, in year 1 you may not get any stock (cliff), in year 2 some of the stock options/shares will vest, in year 3 the you will get more than year 2 but less than year 1, and in year 4 you will get most of the stock. So the grants are made like a pyramid with most of the shares vesting in the last year.
e.g. If you are awarded 10000 stock options in forward vesting they may vest as following: End of Year 1 - 2500, Year 2 - 2500, Year 3 - 2500 and Year 4 - 2500. While, in pyramid vesting they may vest as the following: End of Year 1 - 1000, Year 2 - 2000, Year 3 - 3000 and Year 4 - 4000.
Given the difference in the vesting schedule, Pyramid Vesting incentivizes employees to stick around longer. However, Forward Vesting is much simpler to understand and gives the same increment of stock every year so employees may prefer it. With Forward Vesting it is much easier to estimate the value of the stock options while the company undergoes different stages of funding.
I do not think you need a different vesting schedule for early-stage v/s late-stage startups. Since for most larger companies (Google, Microsoft, IBM etc.) forward vesting of employee stock options is the norm, I assume that the only place where a pyramid vesting schedule can work is in an early-stage startup. Eventually, you may have to move to forward vesting if you are around longer.
These issues were also briefly touched upon in Sam Altman's lecture on "Later-Stage Advice" as part of the CS183b — How to Start a Startup class. His advice was also along the lines that no matter which how you decide to vest the stock options you need to put in place an option management system to be able to track options allocated to employees.
Refresher Grants
Since there was a comment about refresher grants I am adding some details here. With the initial employee offer the stock options that are granted may be supplemented over the years based on good performance. These additional grants are called refresher grants. These grants can vest in the same way as the original ones following either Forward Vesting or Pyramid Vesting. It is a good idea to give refresher grants so that after the end of the initial vesting period the employee still has incentive to continue working for the company.
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