Stock vesting is an important component to consider when offering employees equity compensation as part of their compensation package. It determines when an employee will receive the full right to his/her equity award.
In this post you’ll learn:
What is vesting?
Vesting is the process of gaining 100% ownership of an asset. When employees are granted an asset on day one, they don’t have full control over it until the vesting period has passed.
Once it has passed, they fully own the asset and can exercise (i.e. purchase) and/or sell it.
How does vesting work?
Vesting works by setting up criteria for becoming an owner of an asset. If the criteria haven’t been met, the stock is not yet vested. Here’re the three main vesting criteria:
– Milestone-based vesting: A recipient will be able to earn his/her asset when the company accomplishes a project, e.g. IPO, or he/she achieves performance targets.
– Time-based vesting: Stock options are typically time-based. If an option has a 3-year vesting period, the recipient will need to wait 3 years to receive his/her options based on its vesting schedule which might be cliff vesting or graded vesting.
– Hybrid vesting: Vesting for restricted stock units (RSU) is usually hybrid in private companies.
A vesting schedule heavily determines the attractiveness of equity compensation and the effectiveness of staff retention. Speak with us today if you have any questions about vesting.
Vesting schedules: Cliff vesting, Graded vesting & Immediate vesting
Full Year(s) of Service
Cliff vesting (over 3 years)
Graded/ratable vesting (over 6 years)
It’s a process where a participant receives full award ownership on a given date. Imagine you offer your employees 300 shares of stock options with a 3-year cliff vesting schedule. This means they cannot exercise (i.e. purchase) them until 3 years later. After 3 years, they can exercise them at the initially agreed price (i.e. exercise price) and sell the vested shares.
It’s a process where a participant gains award ownership in intervals. Again, imagine your employees are offered 300 shares of stock options with a graded vesting period of 6 years. After the first year of employment, they would receive 60 vested shares (20% of the total shares) that fully belong to them and they can exercise and sell this portion. The next year, 60 shares, and 60 shares the next year and so on.
With an immediate vesting approach, a participant receives 100% ownership of their shares at the grant date. It means they can exercise or sell the shares right away.
How stock vesting affects employees when they quit?
If an employee wanted to quit but only a small portion of equity has vested according to the vesting schedule, then only the vested equity can be kept by the employee while the unvested equity will usually be forfeited.
Stock options & Vesting:
Sticking with the same example, a participant is granted 300 shares of stock options with 3-year cliff vesting (i.e time-based). If they leave before they hit the 3-year mark, they won’t get any shares. If it’s graded vesting and only 100 shares are vested before they leave, then they can only earn the vested stock options (100 shares) but not the remaining (200 unvested shares).
No tax is due at vesting for stock options.
Note: Incentive stock options typically expire within 90 days of leaving the company, so employees could lose their vested stock options if they don’t exercise them within 90 days.
RSU & Vesting:
The RSU’s vesting mechanism works similarly – You’re only able to take the vested equity with you when you leave. But unlike options, you’ll owe income tax when your RSU vests.
If your company is private when it vests, you’ll then need to pay the tax out of pocket because private companies lack liquidity. So, it’s not uncommon that RSUs in private companies are subject to ‘’Double-Trigger’’ vesting. It means two vesting criteria (usually one time-based requirement and one milestone-based requirement, e.g. IPO) have to be satisfied before the shares are truly yours.
So, with ‘’Double-Trigger’’ RSU vesting, you’re able to sell your stock to pay the tax at vesting.
How we can help with stock vesting
At Global Shares, we’ve helped companies of all sizes and locations to launch their own equity compensation plans.
Our purpose-built platform helps streamline equity administration, including managing different vesting schedules. Through the Global Shares platform, you can easily set up, track and automate all of your vesting schedules from one secure place, meaning less time is spent on administration and managing messy spreadsheets.
If want to make sure your equity is in good hands, contact us for a free demo today.
FAQ about stock vesting
What does vesting mean?
To define vesting, it is a process of gaining full ownership of an asset. So, an employee doesn’t have full control over it until the vesting period has passed. Once it has passed, the asset belongs to the employee and can be exercised and/or sold.