At new and growing businesses, owners often use vesting schedules to allocate equity percentages to employees over time. While using a vesting schedule is typical practice, there are some pros and cons to using one to allocate equity.
Keeping Cash Available
After deciding to offer equity shares to employees, the usual procedure is to implement a vesting schedule. From a business owner’s standpoint, one major advantage of using a vesting schedule is that it lets the company have more cash available to use. Since equity shares are a part of an employee’s overall compensation, less money needs to be used immediately to cover other forms of compensation, such as base salary, sign-on bonuses, or periodic performance-based bonuses throughout the year. This is a major reason why vesting schedules are a great idea for startups or growing businesses.
Saving Money and Retaining Employees
In the long run, a vesting schedule may save the business money. If an employee leaves the company before the vesting of his equity shares is complete, the unvested shares are forfeited and go back to the company. This winds up saving money on people who are not aligned with the long-term vision of the company. The shares that are given up can then be offered to better candidates. Also, due to the nature of equity, a vesting schedule usually helps businesses keep great employees. Better employees want to stay and see their equity shares multiply in value while weaker employees, who probably lack the patience to stay at the company for a long period of time, are more likely to prefer shorter-term rewards.
While there are significant advantages of a vesting schedule, there are some disadvantages. Unfavourable or unreasonable vesting terms might drive great candidates away. Great talent may not necessarily want to join a company that has bad equity vesting terms. Make sure that your business’s vesting schedules are fair for both your company and your employees. If the vesting schedule is too favourable for the employees, bad employees may hang around just long enough to become fully vested (costing the owner shares of the company) and then immediately quit once they receive the shares. This has a double-whammy effect, since the owner loses the shares and then needs to find replacement candidates quickly.
A vesting schedule forces a business owner to complicate the business’s long-term cash flow and financial planning. The accounting of all the shares, percentages, and vesting dates for each employee increases the complexity of the business’s financial books. Because of this, outside accounting and tax professionals must be hired to take care of this portion of the business, which increases costs. Overall, the idea of vesting equity shares over time has its pros and cons for startups and small businesses. Each company is different, and the decision of whether to use vesting schedules to award equity shares should be made with guidance of an accounting or financial professional.