How vesting works

When you buy stock in the public stock market, everything feels relatively simple, right? When markets are open, you can buy, you can sell, you can view minute-by-minute changes to the price. Yeah. So having equity in a private company is not like that. 

Equity, as we’ve already said, represents your ownership of a private company. And that ownership is really hard to access. Plus, there’s all this stuff involved with equity. You have to vest your shares, exercise your shares, and then you have to think about taxes. And if you’ve never encountered any of this before, it can make your head spin.

My name’s Jessica. And in the next couple lessons, we’re going to go really deep into Iris’ equity grant in order to understand two main things. First, how her options are going to vest. And second, how she can exercise her options in order to fully own her shares. Let’s dive in.

If you want to be an equity owner, you typically need to work for a company for a certain period of time. Companies use a process called vesting to encourage you to stay at the company longer. 

Vesting is simple. It’s the process by which you earn the right to shares over a period of time. So you’ll want to understand how your equity vests when you get your options, because depending on the type of equity that you’re granted, your vesting can determine when you might be taxed or when you’re actually able to buy those shares.

There are different types of vesting structures. The most typical type of vesting structure is time-based. So over time you’ll vest more of your options or shares. But there are also other vesting structures, like an event-based structure. This is where your vesting is tied to a certain event, like an IPO or an individual sales target that you need to hit. The last type of vesting structure is a hybrid model, which combines the last two. When two events are required for vesting, that is called a double trigger. The most typical hybrid structure that we see is with a double-trigger RSU, which you may be familiar with if you’re at a later-stage private company.

OK, great. Now we have the basics. So let’s run through an example with Iris using one of the more common vesting structures we see in the marketplace, a four-year vest with a one-year cliff.

If you look at Iris’ equity grant agreement, the date of the grant was January first, 2021. So let’s fast forward exactly one year. At this point, Iris has been working at her company for one year and she’s just hit what’s called the one-year cliff. 

If we take a look at this diagram, we can see that time is on the horizontal axis. And the number of options that Iris has been granted is on the vertical axis. Iris has just reached the one-year mark, which is the one-year cliff that we talk about.

At this point, Iris instantly vests one quarter—or a thousand—of her incentive stock options. Remember she has 4,000 total. So 1,000 is one quarter of that. This is how the one-year cliff works. For the first year of her employment, Iris doesn’t have any vested options. Then when she hits the one-year mark, the first fourth of her entire equity grant is vested in one lump sum.

Everything she’s vested, she is now officially able to exercise, or purchase. And all the shares that she hasn’t vested are known as options outstanding. After she hits the one-year cliff, Iris will start vesting in more frequent increments. Could be monthly, or quarterly. It all depends on what’s specified in her grant agreement. 

So now let’s fast-forward all the way to the end of four years. And as you can see, Iris has fully vested her entire equity grant. This is a big moment for her. So we’re going to throw her a little confetti party to celebrate.

When you get close to the end of an equity grant vesting period, the company might give you a new grant called a refresh grant, because they usually want to have some future equity in play as you’re working with the company.