When approaching the cliff, check your vesting
I commonly see Start-Ups and other early-stage businesses in Kansas City offering equity to employees as an incentive to hire high-level talent.
Incentivizing a workforce is a great idea and one that I encourage. But I tell those companies looking to offer equity, to be careful with whom they share their pie. Businesses can be created in many different ways, but for analogy sake, let’s say all entities are made up of a “100-percent pie.”
It is important to note that once you give a slice of pie to an employee, consultant, advisor or anyone, it is theirs to do with what they please. If you offer a quarter of your pie to an employee in their “Employment Agreement” without any caveats, it is theirs on day one. This means that if your employee quits after 12 days, they still own a quarter of your business entity.
Thus, the best way to protect your business entity is by vesting.
By vesting individuals you can control when you serve them their pie. For example, if you vested an employee 10 percent over a four-year period — and that employee quits after two years — they will have 5 percent of your pie.
This, however, can lead to a problem: too many people can end up having a small piece of your business entity. And how do you avoid having too many owners of your pie? Cliffs.
Cliffs basically allow you to “trial” a hire without an immediate equity commitment.
You agree on the equity amount and vesting period immediately, but if you part ways for any reason during the cliff period, then the departing party gets none of your pie. Apart from that, it acts like normal vesting.
For example, let’s offer an employee 10 percent equity with four-year vesting — but apply a one-year cliff. If after nine months the employee relationship ends, you don’t have to serve any pie. But after the first year, they would receive a 2.5 percent equity stake.
Remember, your business entity is your pie. It is up to the company to decide if it wants to share its pie. But if it does, it’s important to only share it with the right people and under the right circumstances. If you need a business lawyer in Kansas City, call Jeff today.