Jeff Bussgang has a recent post on why vesting schedules should anticipate the time to exit (the gist of it is that vesting should align VC and employee expectations). In his post he notes that time to exit these days is 6 to 8 years.   His fund is likely performing better than the industry because it is more like 8 than like 6.

In response to a comment from me the effect that vesting should be more keyed around expected milestones than arbitrary time frames, he notes that this is what employees get a salary for. Here is the quote:

Employees get paid salaries to deliver results and cash or stock bonuses help focus on milestones. Stock options are really about earning into equity ownership over time. That equity value is only really realized at exit.

I gave this some thought and I agree and disagree. Options, like money and everything else, have a time value and are only motivating if the option holder really thinks she has a decent chance of actually realizing on their value in this lifetime.

Here is a comment to Jeff Busgang’s post from Healy Jones,

Jeff, this is crazy talk! Keep your hands off my vesting schedule; it seems really long to me as is. ;)

Many of the early employees are not likely to be there in 6, let alone 8, years. (No doubt some will.) Many people who are highly suited for the early stage environment and can (and do) make significant contributions are not well suited for the middle or later stage environments.   A classic example is the first CEO. Let’s be honest, a lot of these folks make a real contribution then get moved on. 

Another point is that many people take employment with start-ups for the equity and not for the salary. My sense is that start-ups don’t pay what IBM or Google pay for the same resumes. The equity is an important (perhaps critical) part of the compensation for the day to day work (for which they are being underpaid in the sense that they could get more cash from Microsoft).

So, my point is that pure time based vesting (whether it is slow or fast) does not make sense because it does not compensate for the work done and the contribution made. I have noted this before from the point of view of founders with co-founders or employees that do not perform.

Milestone vesting may not make sense because milestones can sometimes be hard to define and they can be all over the place. 

So, perhaps some amount of time that makes sense in terms of the horizon in which the employee is expected to make a material contribution is a sensible compromise. Whether that should be 2 years, 4 years or 8 years, perhaps depends. 

Jeff is probably right to point out that the industry seems to have settled on 4 because it reflected some sense of historical time to exit.  That does not mean that we have to live with the logic and change the time frames. 

I work with a lot of very early stage companies and as among founder and very early contributors the vesting time frames vary dramatically. Very short time frames (such as one year or even less) and milestone vesting is common. The reason for this is the one I originally gave. Very early stage companies need to get work done, they can’t pay dollars so they pay equity. In this situation, vesting has to make sense in terms of expected contribution. When the contribution is made, you get your stock. 

If you want to hire W2 employees (people looking to work for a salary) and you want to keep them around, pay the salaries, provide the benefits, and vest the options at a slow rate because the options will be one more good benefit, like a 401K.

Many start-ups would like to be at the stage where this is the need. Unfortunately, the nature of the animal is that there are a lot of other phases you have to go through to get to this place. Vesting is one tool you can use to attract people to work for you for less cash than it might otherwise take. Vesting has a time value. The longer it takes the lower the value to the employee and therefore the lower value options have as a form of currency.