There’s a lot of conversation these days around equity compensation. Since the boom of the pandemic, tech valuations have depressed and interest rates remain high. These macro trends have led to what Pave Founder & CEO Matt Schulman calls an “equity program design renaissance”.
In another post, we shared data around how companies in Pave’s dataset approach equity participation. Here, let’s dive into the data around new hire equity vesting schedules and grant structure. Read on to understand what’s going on in the market data, and whether you should follow the trend or sit it out.
The Classic New Hire Equity Compensation Formula
The classic equity vesting schedule for new hire grants is a linear four-year vest, typically with a one-year cliff. This means that employees don’t start earning their equity until they have been with the company for one full year. At the end of that first year, they vest 25% of their equity. After the one-year cliff, the remaining 75% of the equity vests gradually: 1/48th of the total equity vests each month over the next three years. By the end of the fourth year, employees will be fully vested in their equity.
If the employee receives a new equity grant (a refresh grant), the vesting schedule resets. This means that a new one-year cliff will apply from the date of the refresh grant, and the vesting process will start over (assume the refresh grant is structured the same as the new hire grant).
One reason that this vesting schedule became the norm has to do with employee retention. The one-year cliff means that if an employee leaves the company within the first year, they won’t have any options to take with them. If they stay with the company for three years though, they’d vest 75% of their new hire grant. This provides an incentive for talent to stay with the organization so that they can earn more of those valuable options—particularly if they believe the value will be even higher in a liquidity event.
During the pandemic though, macroeconomic forces caused a shift. Interest rates went up, the stock market became increasingly volatile, and many companies saw depressed valuations. As a result, some organizations implemented different strategies to help manage equity burn rates and become more targeted in their vesting practices.
In a Pave webinar on the equity compensation landscape, Matt Schulman was joined by David Knopping, Founder & Managing Director at Alpine Rewards, to see how the data on equity programs is impacted by this shift.
A Shift in New Hire Vesting Practices
“If the value we're delivering to someone is less year-over-year because we just have no choice, we have to deliver less value to manage within our burn, then vesting is a lever we could play with. And companies are playing with it,” David said.
Looking at private companies side-by-side with public companies, the difference is clear. Over time, public companies have increased the variety of vesting schedules for new hire grants, with many more offering two- and three-year grants. At private companies, however, the four-year vest is still overwhelmingly the norm. In fact, private companies have a slight trend toward a longer vest—the numbers of five-year grants have crept slightly upward while shorter vests creep down.
To illustrate the trend even further, this blog post from Levels highlights some examples of unique vesting schedules from public companies. Brands like Rivian and Verity, for instance, offer two-year grants, while Stripe offers an even shorter one-year grant.
Offering shorter vesting schedules comes with pros and cons:
- Pros:
- Saves the company money by not locking employees into low strike prices over four years (later refresh grants would be at a higher strike price)
- Preserve optionality over time, enabling companies to be more targeted in who gets refresh grants, and how much
- Manages the equity burn rate—shorter grants typically include fewer options per employee
“If I was delivering someone $100,000 over four years and now—just given our share price, our burn, our share pool—I can only deliver $75,000, should I do that over three years and the same amount of value vesting per year?” David said. “You can at least say to the employee, ‘you're no worse off’.”
- Cons:
- Less value over time for employees, which could have a negative impact on retention
- Smaller grants can lead to less “shared ownership” culture among employees
Pave Founder & CEO Matt Schulman raised this topic on LinkedIn—See what the LinkedIn community had to say.
Enabling employees to vest their new hire grants earlier can potentially give them an incentive to join the company. And at public companies where those grants are liquid, this may offer more immediate value.
Trends in New Hire Grant Structure
When it comes to grant structure, the standard has been linear, or equal amounts vesting over the course of the vesting schedule. But there are levers to pull here as well. Companies can consider accelerated (otherwise known as front-loaded) grant structures, where a higher percentage of equity vests in the early years of the schedule. Some examples are a 40%/30%/30%/10% split over a four-year grant or a 50%/33%/17% split over three years. The opposite of this is backweighted—like a 10%/10%/40%/40% split—in which more equity vests later in the vesting schedule.
Here, too, public companies are setting the trend. The data shows that while private companies have leaned further into linear grants over time, public companies are increasingly offering accelerated new hire grants.
When it comes to the front-loaded or accelerated grant structure, there are pros and cons here as well:
- Pros:
- For public companies, it reduces immediate RSU burn
- Ensures a competitive edge, making offers more appealing
- Provides immediate value and a more substantial benefit early on
- Cons:
- Less impact on talent retention, since employees will have more vested equity earlier
- Employees might focus on short-term gains rather than long-term goals, as a large portion of their equity has already vested
While this data only drills into new hire equity grants, it’s a safe assumption that the trends are reflected in refresh grants as well.
“In general, it seems like if companies are making a broad sweeping change to new hire, they tend to also make that broad sweeping change to refresh or ongoing—for all net new ones, of course, not retroactively,” Matt said.
Following the Trends in New Hire Equity Compensation
Compared to the world of private startups, public companies aren’t typically thought of as particularly innovative. But the data shows that they are in fact setting new trends when it comes to equity compensation programs. Whether to follow the trend comes down to your business’s financial situation and the type of company you want to build.
For even more, check out our on-demand equity compensation webinar to hear Matt Schulman and David Knopping dive deeper into the topic.
If you’re designing an equity program and need support, Pave can help with equity benchmarking. If you’re ready to add Pave to your compensation tech stack, request a demo today.
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