What is a Cliff?
A
cliff in the context of
entrepreneurship refers to a specific provision in an
equity vesting schedule. It is a period during which the equity granted to an employee, co-founder, or investor does not vest. Typically, this period lasts for one year, but it can vary depending on the agreement. Once the cliff period ends, a significant portion of the equity vests all at once.
Retention: It ensures that team members are committed to the long-term success of the
startup. Employees who leave before the cliff period ends forfeit their unvested shares.
Protection: It protects the company from having to distribute equity to individuals who may not contribute significantly.
Fairness: It ensures that equity is awarded to those who have demonstrated commitment and value to the company over a reasonable period.
How Does a Cliff Work?
In a typical equity vesting schedule with a one-year cliff, no equity vests in the first year. After the one-year cliff, a significant portion of the equity, often 25%, vests all at once. Afterward, the remaining equity vests gradually, usually on a monthly or quarterly basis.
Example of a Cliff
Imagine an employee is granted 1,000 shares with a four-year vesting schedule and a one-year cliff: Year 1: No shares vest.
End of Year 1: 250 shares (25%) vest after the cliff period.
Years 2-4: The remaining 750 shares vest gradually, often monthly, over the next three years.
Cliff vs. Vesting
While a cliff is a component of an equity vesting schedule, it is not the same as vesting.
Vesting refers to the process by which employees earn their equity over time. A cliff is a specific period within the vesting schedule where no equity vests. After the cliff period, vesting resumes according to the agreed schedule.
Common Cliff Periods
The most common cliff period is one year. However, cliff periods can vary depending on the company's policies and agreements. Some companies may opt for shorter or longer cliff periods based on their specific needs and strategies.
Conclusion
In summary, a cliff is a vital component of an equity vesting schedule in entrepreneurship. It ensures retention, protection, and fairness within a startup. Understanding how cliffs work and their importance can help entrepreneurs and employees make informed decisions about equity compensation and commitment to the company's long-term success.