Picture this:
You’ve worked hard at a startup that offers equity compensation as part of the total pay. Throughout your time with the company, you worked diligently to earn your stock options over a multi-year vesting schedule; they only become fully yours after a set time.
Say you decide to leave a company for whatever reason, you’ll forfeit your unvested stock options and only claim the ones that have vested. Here’s how to calculate the total value of your vested interest upon leaving a company.
The same thing happens if the company lets you go due to a layoff or acquisition, unless you have an accelerated vesting arrangement with the startup, allowing you access to unvested stock options earlier than the planned vesting schedule.
In this article, I’ll explore the meaning of accelerated vesting, the different types, why startups use it, and how it affects employees and employers.
I provided a comprehensive guide to equity roll forward in a previous article. Now, I want to tell you everything you need to know about the accelerated vesting of stock options upon termination.
TLDR: Key takeaways from this article
- Accelerated vesting allows employees to gain early access to unvested stock options due to events like termination or acquisition.
- Accelerated vesting can be single-trigger (one event) or double-trigger (two combined).
- Common conditions that activate accelerated vesting clauses include layoffs, company mergers, or restructuring.
- Accelerated vesting arrangements give employees financial security but may result in tax liabilities. Employers who use them to attract talent often risk equity dilution.
- Understand your employment agreement and seek professional advice before finalizing any equity compensation package.
What is accelerated vesting of stock options?
Accelerated vesting is a company policy that enables employees to access unvested stock options before their standard vesting schedule. For example, instead of waiting for the usual four-year vesting period, certain clauses might allow you to vest all remaining options immediately. This typically happens upon specific events, such as employment termination, acquisition, merger, or initial public offering (IPO).
Accelerated vesting ensures employees don’t lose out on equity compensation they’ve worked hard towards when circumstances beyond their control arise.
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Written by Omoruyi Edoigiawerie, a seasoned startup attorney with over a decade of experience. Learn more.
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Types of vesting acceleration
1. Single-trigger acceleration
This clause grants full or partial acceleration of vesting when one condition is met, such as termination without cause, resignation for a “good reason,” or a change in company control.
For example, if you have a four-year vesting schedule and your employment is terminated after two years of employment during a merger, single-trigger acceleration could immediately vest your remaining two years of unvested stock options.
2. Double-trigger Acceleration
This requires two conditions to be met before vesting can be accelerated — usually a change in company ownership followed by employment termination. It’s designed to protect employees while maintaining stability during transitional periods.
For example:
- A startup is acquired or undergoes a significant change in control.
- The employee is terminated without cause (or resigns for "good reason") within a specified timeframe (e.g., 12 months post-acquisition).
Key terms in accelerated vesting
To fully grasp the concept of accelerated vesting of stock options upon termination, here’s a glossary of essential terms and their explanations:
- Vesting: The process through which employees earn the right to exercise or own stock options over time. It’s typically tied to an employee's tenure or performance.
- Vesting schedule: A predetermined timeline outlining when and how employees gain ownership of their equity compensation.
- Trigger events: Specific occurrences that activate accelerated vesting. They can be classified into single-trigger acceleration and double-trigger acceleration.
- Equity compensation: A non-cash form of pay that includes stock options, RSUs, or other equity awards used to incentivize and retain employees.
- Stock options: A type of equity compensation that grants employees the right to purchase company shares at a predetermined price (exercise price) after meeting vesting requirements.
- Restricted stock units (RSUs): A form of equity compensation where employees receive company shares upon meeting specific conditions (like tenure or performance) without needing to purchase them as in stock options.
- Employee stock option plan (ESOP): A formal program through which companies grant stock options or equity to employees, often outlining vesting schedules and acceleration clauses.
- Exercise price: The set price at which an employee can purchase shares under a stock option agreement. The goal is for the stock's market value to exceed this price for financial gain.
- Termination without cause: When employment is terminated for reasons unrelated to misconduct or performance.
- Golden parachute: A contractual provision offering significant financial benefits, including accelerated vesting, to top executives upon termination, particularly after a company acquisition.
- Dilution: The reduction in the ownership percentage of existing shareholders caused by issuing additional shares.
- Fair market value (FMV): The estimated value of a company's shares used for stock option agreements, calculated based on market trends, revenue, or valuation.
- Liquidity event: An occurrence like a company going public or being acquired, allowing stockholders to convert their equity into cash or tradable stock.
- Initial public offering (IPO): The process by which a private company offers its shares to the public for the first time, allowing it to raise capital by selling equity to investors. This marks the company's transition to publicly traded on a stock exchange.
How accelerated vesting works upon termination
To illustrate how accelerated vesting plays out following termination, let’s look at an example.
Example scenario:
- Imagine you have 40,000 stock options with a four-year vesting schedule — 10,000 vest per year.
- After two years, you’re terminated for a reason that’s out of your control, say a company acquisition.
- Given the rate of 10,000 options vesting yearly, only 20,000 would have vested after the two years.
- You lose the remaining unvested options without accelerated vesting.
- With single-trigger acceleration, the remaining 20,000 options vest immediately.
- With double-trigger acceleration, the 20,000 unvested shares vest if termination occurs within the merger’s protection period.
Conditions for accelerated vesting
Accelerated vesting is often triggered by the following:
- Termination without cause: Accelerated vesting often applies if the employer initiates termination for reasons unrelated to misconduct or poor performance. For example, this could include layoffs due to company restructuring
- Resignation for “good reason”: This includes scenarios such as significant salary cuts, demotions, or forced relocation.
- Change in company ownership: When a company is acquired or merges with another, its stock options may become void. Accelerated vesting ensures employees retain the benefits they were promised.
- IPO: Employees may receive accelerated vesting if their equity agreements specify an IPO as a triggering event.
- Special agreements: Executives and senior-level employees often negotiate tailored accelerated vesting clauses as part of their employment contracts.
- Performance milestone: Certain startups offer performance-based accelerated vesting if employees or the company achieves pre-determined performance-based milestones.
Why companies offer accelerated vesting
To attract top talent
Accelerated vesting clauses help startups attract talented employees, especially high-level executives and specialists. Companies can stand out in a competitive hiring market by offering upfront equity rewards and security.
To retain employees
Companies use accelerated vesting to retain top talent, offering reassurance that their equity won’t be lost in termination or company acquisition scenarios. Accelerated vesting incentivizes employees to stay committed during pivotal events like mergers, acquisitions, or organizational restructuring.
For fairness and protection
Accelerated vesting is often seen as a gesture of fairness. It ensures that employees terminated without cause or whose roles fundamentally change receive compensation for their contributions. This can build goodwill and maintain morale across the ranks.
To smoothen mergers and acquisitions (M&A)
Accelerated vesting can help smooth transitions during M&A, ensuring employees receive their earned equity even if their roles are redundant post-sale. This approach reduces friction and assures employees they are noticed.
Pros and cons of accelerated vesting for employees and employers
Pros for employees
- Protects unvested shares from being forfeited.
- Immediate access to stock options provides financial security during unexpected terminations.
- Reward for contributions so far, even if they leave early.
Cons for employees
- Accelerated vesting might trigger immediate tax liabilities, as unvested options become taxable income upon vesting or exercise.
Pros for employers
- Helps attract top talent by offering a safety net for stock options.
- Ensures smooth transitions during mergers or acquisitions.
Cons for employers
- Significant financial impact from accelerated payouts, especially during acquisitions, as more shares are vested at once.
- Potential dilution of shareholder equity value.
Key considerations for negotiating accelerated vesting
For employees:
- Understand the terms: Review your equity agreement carefully. Common terms include “cause,” “good reason,” and “change in control.”
- Negotiate double-trigger clauses: These protect you in case of role eliminations post-acquisition.
- Seek expert advice: Consult legal and financial advisors to assess how accelerated vesting fits your career and financial goals.
For employers:
- Set clear conditions. Define triggering events explicitly in employment agreements.
- Ensure a balance: Balance employee benefits and shareholder interests by offering tailored acceleration provisions for key roles.
- Plan for corporate events: Include vesting provisions that align with the company’s long-term goals, especially in M&A contexts.
- Enlist expert guidance. Consult financial and legal professionals when crafting equity agreements.
FAQs about accelerated vesting of stock options
What does it mean when a stock option is vested?
When a stock option is vested, employees have the legal right to exercise it and purchase shares at a pre-determined price.
Can a company accelerate RSU vesting?
Yes, companies can offer accelerated vesting for RSUs under conditions similar to stock options, such as terminations or acquisitions.
What happens to stock options if you leave a company?
Unvested stock options are typically forfeited unless accelerated vesting applies.
Is accelerated vesting common in startups?
Accelerated vesting is common in startups, especially in competitive sectors like fintech, where equity compensation is a major incentive.
What is the accelerated vesting of stock options upon acquisition?
Accelerated vesting of stock options upon acquisition refers to a clause in an equity compensation agreement that allows employees to gain immediate ownership of unvested stock options when their company is acquired.
Does accelerated vesting attract top talents to startups?
Yes, startups use accelerated vesting as an incentive to attract and retain top talents, much like how businesses use loyalty programs to attract and retain customers.
What happens to unvested shares if an employee is terminated for cause?
Typically, unvested shares are forfeited in the event of termination for cause like theft, as accelerated vesting usually applies only to terminations without cause (e.g., layoff due to restructuring).
Conclusion
Accelerated vesting offers a safety net for employees navigating terminations or significant company changes. It ensures they are compensated for their contributions, even if employment ends suddenly or early. It’s a strategic tool for companies to attract, retain, and transition talent during mergers or acquisitions.
Understanding how accelerated vesting works and negotiating the right terms can significantly improve startups' and employees' financial and professional outcomes. Always seek expert advice to ensure your equity agreements align with your goals.
