Equity Vesting Mechanism: An In-Depth Explanation of Vesting and Cliff

Introduction: Why Do We Need Vesting Schedules?

In startup financing and equity distribution, you may have heard the keywords “vesting” and “cliff.” Simply put, vesting (commonly translated as “authorization period” or “gradual rights acquisition”) is a mechanism that ensures employees, founders, and investors gradually gain ownership of equity over a set period. The cliff, on the other hand, is an initial freeze period within the vesting schedule.

What is the core purpose of this mechanism? To align the long-term interests of all parties, prevent short-term opportunism, and protect everyone’s rights at different stages of company development. Whether in traditional startup ecosystems or the cryptocurrency space, the application of vesting and cliff has become increasingly common.

Definitions and Relationships of the Two Core Concepts

What is Vesting?

Vesting refers to the process whereby employees, founders, or investors gradually acquire rights to equity, options, RSUs (Restricted Stock Units), or other forms of equity-based compensation within an agreed period, according to a predetermined schedule.

There are three common forms of vesting:

Time-based vesting: Employees earn a certain percentage of equity after completing specific periods (e.g., monthly or yearly). For example, a four-year vesting schedule with a 25% annual unlock is the most common pattern.

Performance-based vesting: Employees gain equity after achieving specific goals or milestones. For example, unlocking 50% of equity after launching a new product, and the remaining 50% after reaching $1 million in revenue.

Hybrid vesting: Combining both time and performance conditions.

What is a Cliff?

A cliff is an initial lock-up phase in the vesting process. During the cliff period, employees or investors cannot acquire any equity. Only after the cliff expires do they become eligible to start receiving rights to equity.

For example, a common “4-year vesting + 1-year cliff” contract:

• First 12 months: no equity
• After 12 months: a lump sum of equity (usually 25%)
• Next 36 months: remaining equity gradually released monthly or quarterly

Value of the cliff: It filters out those truly committed to the company. If an employee leaves during the cliff, they forfeit all rights; only those who stay until the cliff ends are eligible for subsequent incremental rights.

Common Vesting Schedule Combinations

In practice, vesting schedules are not fixed. Different companies adopt various combinations based on strategic needs:

Each combination balances long-term commitment incentives and talent mobility.

Innovative Applications of Vesting in the Crypto Space

Compared to traditional equity, vesting mechanisms in crypto projects are more complex and diversified. This is because the crypto ecosystem involves tokens rather than just equity, with participants including investors, developers, and community members.

Vesting in Private Token Sales

Many crypto projects conduct private funding rounds before token launch. To prevent investors from dumping large amounts of tokens during initial trading (known as “dump pressure”), projects often set strict vesting schedules for private sale tokens.

Common patterns:

• 6-month cliff + 12-month linear release: Investors cannot sell for the first half-year; afterward, tokens are unlocked monthly
• 3-month cliff + 18-month linear release: More aggressive funding approach
• Phased cliffs: Different cliffs set according to funding rounds

These financing agreements are usually governed by SAFT (Simple Agreement for Future Tokens) or STPA (Simple Token Purchase Agreements). SAFT applies to projects where tokens are not yet issued, while STPA is for projects with already tradable tokens.

Token Incentives for Founders and Teams

Tokens allocated to founders and early contributors at project inception also require vesting. Common practices include:

• A full vesting period of 3 to 4 years
• A 6-month to 1-year cliff
• Subsequent monthly or quarterly unlocks

This ensures the core team is tied to the long-term development of the project and prevents founders from cashing out immediately after fundraising.

Impact of Vesting on Participants

Significance for Employees/Teams

Vesting links employees’ benefits to the long-term success of the company. It incentivizes them to contribute to the company’s sustained growth rather than making short-term profit-driven decisions. At the same time, vesting also protects employees— even if the company faces difficulties during the vesting period, the rights they have already earned remain theirs.

Constraints on Founders

Investors often require founders’ shares to follow a vesting schedule. This ensures that founders cannot cash out immediately if the project fails or deviates from its original direction. This “interest binding” increases investor confidence in injecting capital.

Protection for Investors

Although investors are rarely asked to set vesting periods, in some high-risk scenarios (such as DAOs involving tokens or emerging platforms), their rights may also be locked. This practice helps maintain the stability of the project’s capital structure and prevents early withdrawal.

Risks and Controversies of Vesting

Despite well-designed vesting mechanisms, several issues need attention:

Over-locking: Excessively long vesting or cliff periods can frustrate employees or investors, especially if the project underperforms.

Liquidity constraints: Large amounts of tokens locked for long durations may lead to insufficient liquidity, affecting trading depth.

Incentive failure: If the company’s performance declines or the project fails, vesting becomes meaningless.

Information asymmetry: In the crypto space, project teams often lack transparency about vesting details, making it hard for investors to assess actual risks.

Summary: Vesting as a Guarantee of Long-term Commitment

From traditional startups to crypto assets, vesting and cliff mechanisms are vital tools to harmonize interests among all parties. By setting reasonable authorization schedules, founders, employees, and investors can work together based on mutual understanding and trust toward the long-term success of the project or company.

Understanding these mechanisms is not only important for entrepreneurs and investors but also valuable for anyone looking to enter these fields. After all, a fair and transparent rights distribution framework is the foundation for attracting and retaining talent in any organization.