Imagine this bad scenario as a small business owner. You offer a new employee a percentage of equity of the company. They get it and start working with your company. After a few weeks or months, though, you realize that this employee is a terrible fit. So you decide to fire that person, but they still have the equity promised to them, and you’ll never get it back. Wouldn’t it be great if you could offer that equity to a more effective employee?
You can get around this possible problem using a vesting schedule to transfer ownership of the shares over a reasonable amount of time. Vesting schedules are important to small business owners your employees have to work at the company for a certain period of time before they actually own 100 percent of the shares you promise them. This strategy aligns your interests with those of your employee, preventing a rogue employee from quitting as soon as they’ve received their equity shares.
While vesting schedules are quite common, a lesser-known feature known as cliff vesting is a valuable tool to include in a vesting schedule. Cliff vesting schedules give the employee 100 percent of their promised shares after a specified period of employment passes. You can use cliff vesting alone or in conjunction with a traditional vesting schedule.
Consider the following example showing how a cliff vest is combined with a traditional vesting schedule. Under this scenario, the employee is offered 480 shares that vest at a rate of 10 shares per month with a cliff vest after 24 months. After one month, the employee owns 10 shares. After six months, the employee owns 60 shares. After month 23, the employee owns 230 shares but once the 24th month is finished, the cliff vest kicks in and the employee owns the full 480 shares.
Cliff vesting is an interesting tool you can use to ensure your employees’ interests align with yours. The concept helps you retain great employees who are inherently worth the equity you promise them.