January 16th, 2014
Tech companies will often include some sort of equity in their compensation packages. It’s an excellent way to motivate employees, as they’re literally invested in the success of the company. For smaller startups, this equity typically comes in the form of options – the option to buy shares at a certain price, hopefully lower than what you can sell them for as the company grows. Larger companies may just give you stock directly in the form of restricted stock units (RSUs). If you want to read more about of how equity works, this eBook is good start.
Whatever form of equity one receives, it rarely comes all at once. The options or RSUs are doled out in staggered increments over the course of several years, typically four. Exactly what percentages of the equity are doled out and when varies, but there’s usually one-year cliff, meaning that the employee receives nothing until she’s been there for a full year. At that point, she might get 25% of whatever she’s entitled to. Once an employee has reached the one-year cliff, there are two common forms of equity distribution. In one, the remaining equity is distributed yearly, 25% every year. In the other, it’s distributed monthly, 1/48th each month. In both cases, the entire 100% is paid out over four years.
The more granular the distribution, the better. If an employee is ready to part ways with their company, which happens, they’ll often wait around however many months until the next equity payment comes in before leaving. During this time, employees can be dead weights, holding their team back because they’re checked out and poisoning the office culture because they’re unhappy. This is especially true if equity is a large portion of their compensation, where leaving before the next payout would be financially illogical.
If there’s a good reason to withhold equity payments to yearly increments after a cliff, I have yet to hear it. I assume that there are conveniences in the paperwork of distributing equity to an employee once a year, but those are certainly not worth the potential productivity and morale costs.