Vesting Schedule Explained: Why 4-Year Cliffs Matter

What Is Vesting? (Core Concept)

Vesting is a legal mechanism that converts equity from a promise to reality over time. You don’t own all your shares on day 1. You earn them gradually by staying and building.

The Core Problem Vesting Solves

• Without vesting: Co-founder A and B split equity 50-50 on day 1. Co-founder B leaves after 6 months. They walk away with 50% of the company despite minimal contribution. Unfair
• With vesting: Co-founder A and B split equity 50-50 but vesting over 4 years with 1-year cliff. Co-founder B leaves after 6 months. They get 0% of their equity (forfeited). Co-founder A stays and earns their equity gradually. Fair

Three Types of Vesting

Type 1: Time-Based Vesting (Most Common)

• How it works: Equity vests on a schedule based on time served (months/years)
• Example: 4-year vesting = vests 1/48 per month (or ~0.2% per month)
• Used for: Founders, employees, advisors

Type 2: Performance-Based Vesting (Rare)

• How it works: Equity vests when company hits milestones (revenue targets, product launch, ARR goals)
• Example: “1% vests when company hits ₹1Cr ARR”
• Used for: Advisors, consultants. Risky for employees

Type 3: Hybrid (Time + Performance)

• How it works: 50% vests on time, 50% vests on performance milestones
• Used for: Senior hires (VP level). Rare

Why Vesting Matters (The Stakes)

• For founders: Protects company if co-founder leaves early. Prevents cap table dysfunction
• For employees: Signals company is well-governed. VCs won’t invest in startups without founder vesting in place
• For retention: Vesting schedule is your retention mechanism. Early departure = you lose unvested equity. Incentivizes staying
• For fairness: Equity is earned, not gifted. Aligns incentives

The 4-Year / 1-Year Cliff (Industry Standard)

95%+ of startups use 4-year vesting with 1-year cliff. It’s the global standard. Anything different raises questions from VCs.

What 4/1 Means (Simplified)

• 4 years: Total vesting period is 48 months. After 48 months, 100% of equity is vested
• 1-year cliff: During months 1-12, ZERO equity vests. Nothing. At month 12, 25% vests at once (the “cliff”). Then remaining 75% vests monthly over 36 more months
• Monthly vesting after cliff: Remaining 75% ÷ 36 months = 2.08% per month (approximately 1/36 of total)

The Vesting Timeline (Visual Example)

Why 4 Years? Why Not 3 or 5?

• Historical reason: Legacy from pre-401K era when big company pension plans used 5-year vesting. Startups offered 4 years as competitive advantage
• Psychological reason: 4 years feels “forever” to early-stage people. 3 years feels too short. 5 years feels excessive
• Business reason: By year 4, founders/employees have built real momentum. Company is either scaling or pivoting. Good checkpoint for vesting to end
• Market standard reason: Everyone uses 4 years. Deviating makes you look like bad actor. VCs expect 4 years

Why 1-Year Cliff Specifically?

• Retention gate: You MUST stay at least 1 year to get ANY equity. Deters people taking job just for vesting
• Minimum contribution: First year proves you’re serious and building, not just riding equity wave
• Company survival: Early stage is hardest. If you leave in first year, you didn’t earn it
• All-or-nothing cliff: 25% vests at once (not gradually). Creates retention gate. Month 11 departure = 0%. Month 13 departure = keep 25%

Cliff Mechanics: Why Month 12 Matters

The cliff is the most important concept. Month 12 is a massive retention event. Here’s why.

Real Example: Founder Scenario

• Day 1 (Jan 1, 2025): Founder A and B each get 500,000 shares (50% each). 4-year vesting with 1-year cliff
• Month 11 (Nov 30, 2025): Founder B is frustrated. Quits. Vested shares = 0 (still in cliff). Unvested shares = 500,000 (all forfeited). Net result: Founder B walks away with $0 equity
• Month 13 (Feb 1, 2026): Founder A is still here. Cliff passed. Vested shares = 125,000 (25%). Founder A owns these forever now. Remaining 375,000 unvested, but already earned 25%
• Month 24 (Jan 1, 2027): Founder A at 2-year mark. Vested = 250,000 (50%). Company valued ₹50Cr. A’s 50% = ₹25Cr (on paper)
• Month 48 (Jan 1, 2029): Founder A at 4-year mark. Vested = 500,000 (100%). Fully owns their stake

The Cliff Impact (Why It’s Harsh)

• Month 11 departure cost: Zero equity vested. Founder B forfeits 100% of their shares (500K shares worth potentially ₹50L+ on paper). Hard lesson
• Month 13 departure cost: Only 25% vested. Founder B keeps 125K shares (₹12.5L on paper). Loses 375K shares (₹37.5L on paper)
• Motivation to stay: Cliff is “all-or-nothing” gate. You MUST hit month 12 to get anything. Creates retention tension. People clock month 12 and feel relief

Cliff Real-World Impact (From Data)

• Founder leaving before cliff (0-11 months): Lose all equity. About 5-10% of co-founders depart before 12 months (usually poor founder fit detected early)
• Founder leaving after cliff (13-24 months): Keep 25-33% vested. About 10% of co-founders depart in year 2 (usually co-founder conflict)
• Founder leaving post-year 2 (25+ months): Less common. Only ~5% of co-founders depart after year 2. Usually acquisition/pivot-related

Why Cliffs Exist (From Cap Table Perspective)

• Problem without cliff: Co-founder leaves after 6 months. They get 6/48 = 12.5% vested. Cap table bloated with inactive founder holding equity. Hard to recruit new hires (“Who’s this person holding 12.5%?”)
• Solution with cliff: Co-founder leaves after 6 months, get 0%. Cap table clean. New founder comes in fresh. Clean onboarding
• Retention mechanism: Cliff makes vesting “sticky.” You must survive 12 months to get anything. Creates psychological commitment

Founder Vesting: Restricted Stock & 83(b)

Founder vesting is different from employee vesting. Founders get restricted stock with reverse vesting mechanics. Critical tax consequence.

How Founder Vesting Works (Reverse Vesting)

• Day 1: Founders get ALL shares immediately (500,000 shares for each co-founder)
• But they’re “restricted”: Company has repurchase right on unvested shares. If you leave before 4 years, company buys back your unvested shares at ₹1/share (or formula price)
• Example: Founder leaves at month 18 with 50% vested. Company exercises repurchase right, buys back 250K shares at ₹1 each (₹2.5L). Founder keeps 250K vested shares

The 83(b) Election (Critical Tax Matter)

This is crucial. Miss the deadline and face huge tax consequences.

• What it is: IRS form filed within 30 days of receiving restricted stock
• Why it matters: Without 83(b), you pay ordinary income tax on restriction lapse. With 83(b), you pay capital gains tax on future gains
• Example impact: Restricted stock worth ₹10L at grant with no 83(b) = ₹10L ordinary income taxed at 30% = ₹3L tax immediately. With 83(b), you pay capital gains tax later when you sell
• Deadline: 30 days from grant date. HARD DEADLINE. Miss it and you can’t file late. Penalty is massive tax bill

Action Item: File 83(b) Immediately

• When: Get founder agreement → Day 1 of incorporation → File 83(b) within 30 days
• How: Work with tax attorney or CPA. Get template from IRS (Form 83(b))
• Cost: ₹5-10K in tax advisory fees. Worth every rupee
• Documentation: File with IRS + keep copy + submit to company + keep for your records

Founder Vesting Best Practice

• Document in Founders Agreement: Should specify 4-year vesting with 1-year cliff, repurchase rights, what happens on termination, 83(b) filing requirements
• Get legal help: Don’t DIY founder agreements. Use lawyer for ₹25-50K. Protects you from disputes
• All founders same schedule: Even if one founder does more work, equal vesting schedules prevent future conflicts

Employee Vesting: Stock Options & RSUs

Employee vesting is different from founder vesting. Employees get options (right to buy) or RSUs (restricted stock units), not shares directly.

Stock Options (Most Common for Startups)

• What you get: Right to buy shares at strike price (usually set at FMV at grant date)
• Vesting mechanics: 4-year vesting with 1-year cliff. Options vest (become exercisable) on schedule
• Example: Get 10,000 options at ₹500 strike. After 1-year cliff, 2,500 options vest. After 4 years, all 10,000 vested. You can exercise and buy shares at ₹500 each
• Key difference from restricted stock: You don’t own shares until you exercise. Vesting just gives you right to exercise

RSUs (Restricted Stock Units – Tech Companies)

• What you get: Promise of shares on vesting date (not immediate ownership)
• Vesting mechanics: Same 4-year vesting with 1-year cliff
• On vesting date: Company issues actual shares to your account
• Tax event: When RSU vests, you owe income tax on fair market value at vest date (like perquisite income)
• Less common in early-stage startups: Usually used at Series B+ when company is valued at ₹50Cr+

Vesting Schedule for Employees (Standard)

What Happens to Vesting When You Leave

• Before cliff (0-11 months): Lose all options/RSUs. Forfeited
• After cliff (12+ months): Keep vested options/RSUs, lose unvested. Usually 90 days to exercise vested options
• Fired for cause: Company may have “bad leaver” clause that cancels all vested options. Very rare and controversial
• Laid off without cause: Usually get all vested options + may get extended exercise window (6-12 months instead of 90 days)

Acceleration Clauses: Double-Trigger vs Single-Trigger

Acceleration clauses let unvested equity vest immediately if certain events happen (like company acquisition or employment termination).

Why Acceleration Matters

• Scenario: You’re founder/employee with 50% unvested equity (2 years in). Company gets acquired. New owner lays you off immediately
• Without acceleration: You leave on day 1 of acquisition. Your 50% unvested equity is lost. Massive wealth destruction
• With acceleration: Depending on clause type, unvested equity accelerates (vests early). You keep your equity stake at acquisition

Type 1: Single-Trigger Acceleration

• How it works: Unvested equity vests immediately when ONE event occurs (usually change of control / acquisition)
• Example: Company acquired at ₹500Cr. You have 50% unvested. Automatically vests. You keep your full equity stake through exit
• Founder benefit: Huge. Protects against acquisition layoffs
• Company perspective: Expensive. All founders get instant full vesting on acquisition. Discourages acquisitions if buyer wants founder retention
• Market prevalence: Rare. VCs usually don’t allow (want retention post-acquisition)

Type 2: Double-Trigger Acceleration (More Common)

• How it works: Unvested equity vests only if TWO events occur: (1) change of control AND (2) involuntary termination within 12 months
• Example: Company acquired at ₹500Cr. You keep your job for 6 months. New owner lays you off. Now two triggers met: (1) acquisition happened, (2) you got laid off. Unvested vests
• Founder benefit: Good. Protects against acquisition layoffs but not if you stay
• Company perspective: Balanced. Founder stays post-acquisition = no extra vesting. Founder leaves = gets accelerated vesting. Aligns incentives
• Market prevalence: Standard. 70%+ of acquisition agreements have double-trigger acceleration

Single-Trigger vs Double-Trigger Comparison

Negotiating Acceleration Clauses

• As founder: Push for single-trigger (best case) or double-trigger with 12-month window (most likely). “We’re taking risk. If acquired, we should get full vesting”
• As investor: Usually resist single-trigger (makes acquisition harder). Accept double-trigger as standard
• In term sheet: Should be specified clearly. “Double-trigger acceleration: 100% of unvested options vest if (1) change of control AND (2) involuntary termination within 12 months”

Bad Leaver Clauses & Forfeiture

Some startup agreements include “bad leaver” clauses that let company forfeit even vested equity in extreme cases.

What’s a Bad Leaver Clause

• Trigger: Employee leaves under “bad” circumstances (fired for cause, violation of non-compete, fraud, etc.)
• Consequence: Company can repurchase vested shares at ₹1/share (or formula price, not fair market value)
• Impact: Employee loses equity value. Usually devastating

Example: Bad Leaver in Action

• Year 2: Employee has 50% vested (50,000 shares out of 100K). Company valued ₹50Cr. Employee’s vested equity worth ₹25L on paper
• Employee fired for cause: Caught stealing code. Bad leaver clause triggered
• Company repurchases: Buys back 50K vested shares at ₹1/share. Employee gets ₹50K. Lost ₹25L of paper wealth

Bad Leaver Clause Red Flags

• Too broad “for cause” definition: Should be specific (fraud, theft, IP violations). NOT generic “violates policies”
• Non-compete violations: Some agreements treat non-compete breach as “bad leaver”. Usually contested. Avoid if possible
• Overly punitive repurchase price: Should be ₹1/share or original strike price, not ₹0

Negotiating Bad Leaver Clauses

• As employee: Negotiate narrow definition of “bad leaver”. Should only include: (1) fraud, (2) criminal activity, (3) IP theft, (4) non-compete breach
• Avoid: Generic “material breach of agreement” or “violation of company policies”
• Repurchase price: Negotiate ₹1/share minimum or original strike price (not ₹0 or penny value)

Negotiating Vesting: What to Push For

Founder Vesting Negotiation Checklist

• Check 1: Vesting schedule. “We want 4-year vesting with 1-year cliff. This is market standard” (non-negotiable)
• Check 2: Cliff amount. “At 1-year cliff, 25% vests (standard). We’re not negotiating this” (non-negotiable)
• Check 3: Acceleration. “We want double-trigger acceleration on acquisition. If we’re laid off post-acquisition within 12 months, 100% vests” (negotiable)
• Check 4: 83(b) filing. “We’ll file 83(b) within 30 days. Company will document this” (non-negotiable for founders with restricted stock)
• Check 5: Repurchase rights. “If we leave, company can repurchase unvested at ₹1/share. Vested shares are ours” (standard)

Employee Vesting Negotiation Checklist

• Check 1: Vesting schedule. “We want 4-year vesting with 1-year cliff” (standard, market expectation)
• Check 2: Cliff length. “Can we negotiate 6-month cliff instead of 12?” (only if company is Series B+ and competitive talent market)
• Check 3: Acceleration. “If company is acquired and I’m laid off, do my vested options accelerate?” (ask about double-trigger)
• Check 4: Exercise window. “If I leave, how long to exercise vested options?” (push for 6-12 months, not 90 days)
• Check 5: Bad leaver clause. “What triggers bad leaver status?” (negotiate narrow definition)

When to Negotiate Differently

• Early stage (Seed), you’re co-founder: Accept 4/1. Non-negotiable. VCs require it
• Series A+, you’re key hire: Can push for 6-month cliff instead of 12-month (rare but possible)
• Series B+, you’re executive: Can negotiate acceleration clauses + extended exercise windows
• You have competitive offers: Leverage them. “Company X offers double-trigger acceleration. Will you match?”

What NOT to Accept

• Vesting schedule >5 years: Red flag. Unusual and punitive
• Cliff >18 months: Uncommon. Only justified at growth stage
• No acceleration on acquisition: At minimum, ask for double-trigger
• Bad leaver clause with undefined “for cause”: Too much company discretion
• Exercise window <90 days: Unrealistic. Push for 180 days minimum