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Share Options in Early Stage Tech – Vesting or Reverse Vesting: Which Way Is Best?

on Friday, 14 January 2022.

'Vesting' and 'reverse vesting' are terms that are often used in the context of early-stage technology companies but what do these terms mean and when are they relevant?

Vesting

'Vesting' is the term used when someone is entitled to an increasing number of shares over time – usually by way of share options.

For example, the option holder may be granted options over shares on an incremental basis over, typically, a three to five-year period. Often, the option holder will be an employee, so this mechanism incentivises the option holder to stay with the company for the long term. In some cases, options are used to top up the employee’s salary if the company is unable to pay the market rate for that employee’s salary.

The vesting schedule can be created so that it has a 'cliff', meaning that if the option holder leaves the employment of the company before an initial vesting period has passed, the option holder will not be entitled to any shares.

Options can be drafted so as to contain more complex provisions, such as making the vesting subject to performance criteria (by the company, the team or the particular employee) or particular events (for example, the sale or listing of the company).

Vesting provisions are most appropriate for incentivising employees. There are various tax-efficient option schemes (for example, Enterprise Management Incentive schemes) that can be used by many early stage technology companies.

Reverse Vesting

As the name would imply, 'reverse vesting' is the opposite of vesting as shares are issued upfront. If the shareholder leaves the employment of the company before the end of the vesting period, the shareholder will have to sell their unvested shares (either back to the company, if the company can satisfy the buyback rules under company law, or to the other shareholders, or an employee trust). The reverse vesting period is typically three to five years.

Reverse vesting schedules are most appropriate for founder shareholders as the founders will already hold shares and will not want to relinquish them (both for voting and tax reasons). However, a reverse vesting schedule will provide a useful mechanism to incoming investors to help ensure that the founders stay with the company for a particular time period.

The reverse vesting schedule will also provide co-founders with assurance of each co-founder’s commitment to the company. As with forward vesting schedules, additional criteria can be added (for example, performance targets) as part of the reverse vesting mechanism.

Conclusion

Vesting and reverse vesting are both useful mechanisms but are distinct from one another and care should be taken to ensure the most appropriate mechanism is used.

This article was first published in Business Leader.


For more information contact Emma Cameron in our Technology team on 07939 261 632, or complete the form below.

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