Vesting is a condition on ownership, not a payment.

Vesting is a condition, not a payment

The word sounds like money arriving. It is not. A vesting schedule is a condition attached to equity that was already granted on day one. The grant exists from the moment the board approves it. What changes over time is whether the condition has been satisfied, and therefore what the company can still take back.

This distinction is the whole subject. Read an offer letter as "25% of my equity arrives at twelve months" and you will be surprised twice: once when you learn that with options you still have to pay the strike price (/equity/strike-price) to turn a vested right into a share, and again when you learn that a vested option expires if you do not exercise it inside the post-termination window.

An option vesting and restricted stock vesting are different mechanisms

A stock option is a contractual right to buy a fixed number of shares at a fixed price. Vesting governs when that right becomes exercisable. You own no stock at all until you exercise and pay. For an incentive stock option there is no regular income tax at grant and none at exercise under IRC §421(a); for a nonstatutory option there is generally no tax at grant where the option has no readily ascertainable fair market value, which is the normal private-company case under Treas. Reg. §1.83-7.

Restricted stock is the opposite shape. The shares are issued and outstanding from day one. The holder is a shareholder of record who can vote them. What vests is not the stock — it is the lapse of the company’s right to repurchase the unvested portion, usually at the original purchase price, if the holder stops providing services. Because real property changed hands at issuance, IRC §83 applies from the start, which is what makes the 83(b) election available.

An RSU (/equity/rsu) is a third shape again: an unfunded contractual promise to deliver shares later. Vesting an RSU transfers no property either, which is precisely why an 83(b) election is not available for one. Three instruments, three different things happening on the same calendar date.

The four-year schedule with a one-year cliff

The default in US startup grants is four years total, a twelve-month cliff, then monthly vesting for the remaining thirty-six months. At the cliff, one quarter of the grant vests in a single step. Before the cliff, nothing vests at all — not a prorated slice, not a partial month. It is a step function, and it is deliberate.

Two details in that table do real damage when people miss them. The first is month 11: someone who leaves one month before the cliff has zero vested equity, however good the year was. The second is month 13, where the grant is 27.08% vested rather than a round number. Monthly vesting produces fractional percentages forever, which is why the shares, not the percentage, are the figure worth tracking. The vesting calculator (/tools/vesting-calculator) exists to do this arithmetic for a specific grant and start date.

Why the cliff exists

A cliff is a mutual trial period expressed in equity. Neither side knows at the offer stage whether the hire will work. The cliff means neither side is locked in: the company does not put a two-month hire on the cap table permanently, and the employee is not asked to earn ownership one day at a time during the period when the fit is least certain.

There is an unglamorous administrative reason too. Every person who exercises even a small vested position becomes a shareholder of record who has to be tracked for years: notices, signature pages, stock-power forms, an address that has to stay current through an acquisition, and an information return for each ISO exercise under IRC §6039, delivered to the holder by January 31 of the following year on Form 3921. A cliff keeps short tenures out of that machinery entirely.

None of this is law. No provision of the Internal Revenue Code prescribes four years or a twelve-month cliff. The code sets outer limits on the instrument, not the pace: an incentive stock option cannot have a term longer than ten years under IRC §422(b)(3), five years for a holder of more than 10% of the voting power under §422(c)(5). Between those limits, the schedule is whatever the plan document and the grant agreement say. Four-and-one is a convention that stuck because it balances retention against fairness well enough for most companies to stop arguing about it.

Monthly, quarterly, or annual — frequency is not a detail

After the cliff, the plan sets how often the remaining shares release. The interval looks cosmetic and is not. Vesting is measured at the end of each period, so anyone who leaves partway through a period loses the whole period. On a quarterly schedule that is up to three months of unvested work; on an annual schedule it is up to twelve.

Back-loaded schedules

A back-loaded schedule pushes more of the grant into the later years — 10/20/30/40 across four years, say, instead of an even 25 each year. Larger and later-stage companies use them, and so do companies granting equity as an explicit retention instrument rather than a hiring incentive.

Back-loading is not automatically predatory, and it is worth being even-handed about it. If a company grants a larger headline number and back-loads it, a leaver at year two may still be better off than under a smaller even grant. The honest criticisms are different: back-loading transfers risk to the employee, because the later tranches are the ones most exposed to the company failing, being acquired on bad terms, or the role changing. It also weakens the signal a grant sends, since the headline number no longer describes what a typical tenure actually earns. Read the schedule and the number together, never the number alone.

Milestone and performance vesting

Some grants vest on outcomes rather than time: shipping a product, reaching a revenue threshold, closing a financing, obtaining a regulatory approval. The idea is clean and the administration rarely is. Someone has to decide whether the milestone was met, and that decision lands in a board meeting rather than a spreadsheet. Partial achievement is the usual dispute — the product shipped two quarters late, or shipped without the feature the milestone named.

Performance conditions also complicate the accounting. Share-based payment expense is measured and recognised under FASB ASC Topic 718, and an equity-classified award is measured once at grant-date fair value. Where vesting depends on a performance outcome, the expense depends on management’s assessment of that outcome, so the reported number moves when the assessment moves. Time-based vesting has none of that ambiguity, which is a large part of why it dominates.

Reverse vesting, and why founders do it to themselves

Founders do not usually hold options. They hold shares, purchased at incorporation for a nominal price, and those shares are subject to a company repurchase right that lapses on a schedule. This is reverse vesting: the stock is issued and genuinely owned from day one, and what vests away is the company’s ability to buy it back. Legally it is restricted stock, which means IRC §83 governs it.

The 83(b) election is what makes the structure workable. Without it, the default rule taxes the stock as each tranche of the repurchase right lapses, valued at whatever the stock is worth on that date — so a founder whose company succeeds is taxed repeatedly on a rising valuation for shares they cannot sell. An 83(b) election flips that to a single measurement at transfer, when the stock is worth almost nothing. IRC §83(b)(2) requires the election to be filed with the IRS no later than 30 days after the date of transfer. There is no statutory extension and no cure. Rev. Proc. 2012-29 contains a sample form; whether an election is right for a particular holder is genuinely fact-specific and a question for a CPA.

Investors insist on founder vesting even when the founders have been at it for two years, and the reason is not distrust. A cap table where one founder can leave in month fourteen holding 30% of the company is a fundraising problem for everyone who stays, because the remaining team is then diluted by dead equity while doing all the work. What experienced founders negotiate instead is credit for time served: the vesting commencement date is backdated to when they actually started, so two years of work is recognised as vested at signing and only the remainder is at risk. Ask for it explicitly — it is normal, and it is not usually offered unprompted.

What happens when someone leaves

Vesting stops on the termination date. Not the date of the resignation email, not the last day of the notice period unless the plan defines it that way — the date the plan says service ended. Everything unvested at that moment is forfeited, and for restricted stock the company typically exercises its repurchase right over the unvested shares.

For options, the vested portion then enters the post-termination exercise period. Ninety days is the common default. If the holder does not exercise and pay within it, the vested options expire and are returned to the pool. Some companies extend the window to several years, which is a genuine benefit — but it has a tax consequence that is easy to miss. IRC §422(a)(2) requires an incentive stock option holder to have been an employee from the grant date until three months before exercise. Exercise later than that and the option is no longer an ISO; it is treated as a nonstatutory option, and the spread at exercise becomes ordinary income under §83(a) and Treas. Reg. §1.83-7 rather than an alternative minimum tax adjustment. An extended window does not remove the decision; it moves it and changes its character.

Plans also distinguish good leavers from bad leavers. A good leaver — resignation, redundancy, sometimes disability or death — keeps their vested equity subject to the normal window. A bad leaver, meaning termination for cause as defined in the document, can lose it. Some plans go further and allow the company to claw back or repurchase already-vested shares on a for-cause termination. The definition of "cause" is therefore worth reading closely at offer stage, because it is the clause that decides whether vested means permanent.

Vesting commencement date, grant date, offer date

Three dates, routinely conflated, and the confusion moves an entire cliff. The offer date is when the company sent the letter. The grant date is when the board or its delegate approved the award and fixed the strike price. The vesting commencement date is the date the schedule starts counting from, and it is usually the first day of employment — often weeks or months before the board actually approves the grant.

Acceleration: when the schedule stops applying

One set of terms can override the schedule entirely. Acceleration clauses vest some or all of a grant early on a change of control — single trigger on the deal alone, double trigger on the deal plus a qualifying termination. They matter most at exactly the moment when equity finally becomes worth something, and the definitions in the document do all the work. That subject has its own guide (/equity/acceleration), including the golden-parachute and ISO-limit interactions that acceleration can trigger.