When any startup gets off the ground, there’s a typical playbook that everyone ascribes to. But Shane and I knew when we started XMTP that we didn’t want to be a typical startup. We wanted to meet every question with curiosity and every decision with intentionality.
The DNA of a startup is not magically born out of thin air, crafted perfectly from the onset in whatever the trendy new document tool happens to be. It’s created over time with every single decision, however big or small, adding to it. Each opportunity for a decision creates a fork in the road, and whichever path is chosen forever alters that DNA.
With that in mind, one of the many things that has come up already is the question of employee compensation and more specifically equity comp.
For as long as I’ve been working in startups (and for a long time before that), the standard way of providing employees with equity in the company always came along with vesting, and a cliff. However, we’re not sure that’s what’s best for all parties anymore and we’re changing it.
Vesting, and cliffs
The vesting of stock is intended to incentivize the employee to stick around and to earn their stock over time. Often that means that a new employee’s stock vests over 48 months. With each month that they’re working at the company, they’ll earn 1/48th of their stock, usually in the form of an option to purchase shares at a very low price (based on when they joined). Note: we still like this part, so it’s sticking around.
The “cliff” part of vesting is also par for the course: a period of time where stock continues to vest, but if the employee leaves prior to a specific date they receive none of it. That time period is usually a year. So given all of the above, what does that mean in practice?
- Employee stays for 11 months: they get nothing
- Employee stays for 12 months: 25% of their stock vests all at once
Cliffs create perverse incentives
Imagine as a new team member, you’re 9 months into a startup where you’re miserable. Maybe the company is doing so well, or you’re having a really hard time jibing with the culture, and you feel like the best thing would be to try something else. Now you’re stuck with a really challenging question: leave early and give up the 20% of stock you’ve vested, or grin and bear it for another 3. Neither choice is a good one.
This is often what people call “golden handcuffs”—when you really want to leave something but doing so would be giving up just enough upside to make it a very difficult decision. What’s worse is that should the employee decide they want to ride it out and get to the 12 month mark, they’re not going to indicate their situation to the employer for likely fear that they’d be terminated early.
In the first example where the employee leaves early, that’s ultimately only good for the company. While both the employee and the company took on a risk by joining up, only the employee bears the risk here—and that sucks.
In the second example, it’s bad for both parties. The employee is miserable, and will likely underperform for that period of time, simply because of a lack of interest. The company will share the burden of their underperformance, but also lose an additional portion of equity equal to the extra 3 months they’re sticking around.
Why does the cliff exist?
When we asked around to various other founders and attorneys the answer was pretty simple: if an employee leaves early, you don’t want to have them on the cap table. Typically this is associated with situations where “it just doesn’t work out” or perhaps they’re “not the right fit.”
But almost every example (save for termination-for-cause) felt like it was actually the business, not the employee, who is responsible for something “not working out.”
It’s the company’s job to interview, thoroughly evaluate, and vet new people joining the team. When someone seems to be a poor fit a number of months in, likely that meant that something didn’t come up in the interview process. At that point the company can choose to terminate, or perhaps help guide the team member through an opportunity for correcting the perceived issue.
So what happens if the company changes the roadmap six months into a new employee’s tenure, and their position no longer fits with the direction? How about if due to unforeseen circumstances, an employee needs to leave at the 10th month? Sure, companies could make one-off exceptions in each case, but that is not an equitable nor transparent process for the rest of the team. It’s unfair.
We wanted to come up with a different solution.
Goodbye, vesting cliffs
While we still believe that vesting is a good thing for all parties, we think that the cliff is ultimately an unfavorable thing for employees and it needs to go. Given the above example, in the event that we have a team member that’s 9 months into their time at XMTP and is unhappy, we want to know about it. Maybe it was actually an avoidable departure and we now have an opportunity to rectify the situation, which is advantageous for both parties.
Otherwise, they should just be free to go without the pain of sticking around, and take their 9 months worth of vested stock with them!
Eliminating vesting cliffs will force us to make our hiring process a bit more stringent than perhaps peers that still have vesting, as there’s a bit more downside to letting someone go. But that’s our responsibility to bear.
In the long run, we definitely think this will be what’s best for our future team members as well as a positive thing for the company.
What’s not changing?
So that we can be 100% clear on what’s different and what’s not:
- Only the industry-standard one year cliff is going away
- We still like the traditional 4 year vesting schedule for equity
- Nothing is changing about strike price, etc.
We’re building a different kind of startup here at XMTP: one that puts deep thought, curiosity and intentionality into every decision we make. If that’s something that resonates with you, then we’d encourage you to reach out. Hit us up on Twitter or our contact page or say hi to us personally here: Matt & Shane Mac
Check out our career opportunities here: careers.xmtp.com.
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