From time to time, I will write about some of the terms and conditions of employee stock option plans that can have a major impact for the founder(s) at the end of the day. Given reader response to my previous blogs on the option subject, I want to call attention to vesting.
The vesting of stock options over some designated period can have dramatic economic impact for founders.
Stock option plans will have a vesting period where the right to purchase the granted stock options increases annually and sometimes monthly. So the stock optionee gets 1,000 options that vest over a four year period in quarterly amounts, meaning that employee vests and has the right to purchase the options following the completion of each year of employ. In our example, Employee has the right to buy to 25o options after year one of employment. The Employee will usually have that right for some period of time so long as they stay in the employ of the company. It can be up to 10 years to purchase the vested options.
The question arises -- if the founder is the source of the original stock options to supply the stock option pool -- where do ungranted or un-vested options go when the company sells? Consider an example where the ungranted and granted but un-vested options total 10% of the company at the time of company sale. These options were all originally the founders' shares. Where do they typically go at exit? The custom is for them to divided on a pro rata basis amongst existing shareholders. So if investors hold 70% of the company and management/founders hold 30%, then the shares will go 70% to the investors and 30% tothe founders/management.
In this oversimplified example, the issues are obvious. In real life, the sale frequently occurs after the original option pool has long been exhausted and the bulk of the options are vested to the grantees. That said, better to be in command of the issue than not.