Vesting

What does it mean to be vested? Well, you probably already know what it means to be invested. But vested, in a financial sense, has almost nothing to do with cashmere. In most applications, the term "vested" refers to stock option grants. And if you don’t know what a stock option is, stop watching now and go watch our stock option video first.

These things are complex in the way they work, because they’re more or less the modern-day equivalent of golden handcuffs. And not the Fifty Shades kind. When an employee joins a typical, private, small Silicon Valley technology company, they’re granted, say, 20,000 stock options in the company. The standard structure of an ESOP, or employee stock option plan, is that the options vest over 4 years with a 1-year cliff.

What does all this mean? Well, the 1-year cliff means that an employee vests, or owns zero of the options she has been granted until she hits her 1-year anniversary at whatever.com.

It kinda/sorta works like this: your parents have decided to give you $20/month on your 14th birthday, but you don’t get to start collecting it until your 15th birthday. And on your 15th birthday, you get a big fat check for $240. That’s 12 months times 20 bucks, using advanced calculus there. Now that you’re 15, you get $20 a month for three more years, or 36 more months until you turn 18, and then you’re on your own. No more allowance for you.

So now let’s take this structure and apply it to a stock option grant. The employee is granted 20,000 options. She gets none for the first 12 months, but then, after 12 months, she vests or "wears" ¼ of the options she was granted. She now legally has title ownership of those granted options. Even if the company fires her the next day, she still keeps those options. But going forward, she’ll vest monthly for another 36 months, for a total of 48 months to fully vest into ownership of the 20,000 options.

Why the 1-year cliff? Because many employees simply don’t work out at startups. And, because resources are slim, companies have to fire employees who aren’t cutting it quickly. Or they go bankrupt, and everyone's out of a job. The 1-year cliff exists so that companies can evaluate employees carefully before granting them a meaningful ownership stake in the company. Note that these are just options she’s vesting into; she does not own the stock. If she wants to buy out the options, she’ll pay per share whatever the strike price is. And you learned that $5 word from watching the stock options video, right?

So...if she has 20,000 options after 4 years she’s vested into, and then wants to leave with owned shares, and the strike price is 25 cents a share, she’ll have to write a check to the company for 25 cents times 20,000, or $5,000, to then own 20,000 shares. If the company goes public or is sold for, say, $30 a share, she sells 20,000 times 30 bucks, for 600 grand.

Just think of all the fancy vests you could buy yourself with that kind of cash.