Share Vesting: All You Need to Know
Are you planning to issue shares to your employees? If so, do you know all about the possible vesting plans you can offer your employees with? Well, share vesting is a very important part of issuing shares to your staff, and helps with controlling the ownership of the company. Read on to learn more about share vesting.
What does Share Vesting mean?
Vesting is a legal term, which means to earn or give authority of a future or a present payment, benefit, or asset. And when shares are involved, it is referred to as share vesting. This term refers to the period when an employee receives non-forfeitable rights over employer-provided stock incentives (or to employer-provided assets over time), based on how long an employee has worked for a company. Moreover, if a company sets up a vesting schedule, it determines when an employee would obtain full ownership of the asset or financial instrument.
To make it simpler, let us say that Company X has put aside a small piece of ownership of stocks for an employee. However, Company X has clearly set down some specific conditions to be met before the shares are assigned to that employee. These shares are termed as unvested shares.
Once the period passes, and the conditions are met, that employee gets ownership of the shares. And with this, that employee is now allowed to transfer or sell it to any third-party. On the other hand, if the stocks have not yet vested, that employee is not eligible for stock ownership and does not have the rights to sell the shares to another party.
Share Vesting is the length of time before 100% of the shares are awarded to your shareholders. And the share vesting plan comprises of the rules that define how and when the shares will be vested.
Share vesting is a powerful method to further invest time wisely, ensuring that all the business interests are properly safeguarded. It is a plan that employers use to reward their most potential and vetern employees by offering them with shares as compensation. In fact, it is considered as one of the best ways to retain and reward an employee.
Share Vesting Explained Better With an Example
Let us take an example that an employee has been working in your company for a long time now and you decide to offer this employee with a reward for their contribution to the company. In this case, you can offer them with the shares of your company and place a vesting plan on the shares.
Now, the vesting plan would let us know when the employee gets all the shares and rights to either keep or sell the shares. A vesting plan is usually for a period of 3 or more years. The vesting plan will not just offer the employee with a reward, it is also a way to ensure that they stay in the company at least until the shares are vested. After that, it is normal for employees to stay as they too own a part of the company.
Back to the example, you create a vesting plan that has a four year period before the shares get vested completely. And with this, you also add the cliff of one year.
Other than the cliff period, there is another rule that is added to the plan called the after cliff. This is the time interval after which the next percentage of shares (after the first part has been issued) will be awarded to the shareholder. And the rest of the shares will be awarded after this interval till the vesting period is over.
Now, with a four year vesting period and a one year cliff period, the employee will be able to get 25% of the total shares they are awarded after one year has passed after the vesting period started. This is a quarter of the total shares. Plus, even though the employee gets the 25% of the shares after one year, terms can be set so they won’t be able to transfer or sell the shares until all the shares are vested completely.
With this, a company can protect its beneficial assets, which is the employees and also reward them for sticking with the company for a long time. If an employee decides to leave the company before all the shares are vested, the employee will not be awarded with any shares. This means that all the shares will be taken back into the company’s account.
Usually, this type of vesting structure is called “Time-Based Vesting.” After a specific period (mostly after one year), the vesting period commences. All the conditions and rules are created by the founder or the board members of the company. A prior agreement is made, which states that if the employee leaves before the unvested shares are vested, they will get nothing.
Here is an example of a simple breakdown of “Time Shares Vested”. In this case, the vesting period is 4 years, the cliff is one year and the after cliff is 3 years. This is how the shares will be vested:
|Period of Time Shares||Vested|
|Up to One Year||0%|
|At One Year||25%|
|At Two Years||50%|
|At Three Years||75%|
|At Four Years||100%|
From the above table, we could conclude that after reaching the one year benchmark, 25% of the shares are vested. And further, they accrue at just over 25% per year until 100% of the shares has been vested. This is assuming that it accrues yearly. There are plans where the shares are accrued monthly. For instance, if the after cliff value is 1 month, then once the 25% is given when a year passes, the remaining shares would be accrued at 2% per month. In addition, there is always a flexible provision to structure your vesting period.
What are the types of Share Vesting?
You now know that a vesting schedule is considered as an incentive program, which is set up by an employer. And an employee gets the full ownership of certain assets (usually, retirement funds/stock options) when the program is fully “vested.” With such provisions, the employees stay longer with any company.
Moreover, to be 100% vested means that as an employee, you could obtain every benefit possible from the company shares. But the benefits are revoked in case you are fired or you decide to leave the company mid-way. So, if you work hard for your company, at some point your employer may offer you with the benefit of owning shares. And if this situation comes up, you need to know that there isn’t just one kind of vesting plan. There are many types.
Here are three main types of vesting schedules that are popular in the market:
1. Immediate vesting
The first type of share vesting is usually termed as Immediate Vesting. With an immediate vesting plan, the employees receive 100% ownership of the shares offered to them through the plan. They get this ownership immediately and pay for the shares as per the agreement made with the owner.
This plan is usually used when an employee has worked for more than 5 or 10 years with the company and the employer trusts that they will stick with the company for longer. In short, immediate vesting is when the person receives all the shares immediately and they pay for it (or as per the agreement with the employer).
As per this plan, if the employee leaves the company after getting the shares, the shares cannot be revoked by the company. This means that the employee get the shares immediately and it is their decision on what to do with the shares.
2. Cliff Vesting
Cliff vesting, unlike immediate vesting, is when the shares are offered to the employee in large chunks and after certain intervals. If you decide to leave the company before the cliff vesting period is over (assuming that you have obtained half the shares), you will not be able to take the shares from the company.
The shares will be revoked by the company and you will have to leave empty-handed. And if you wait until that period of time( usually, not more than three years), you could own it all. In short, this plan is the most popular plan used by companies so that they do not lose employees as the company grows.
3. Graded Vesting
Graded vesting is somewhat like cliff vesting. In this type of vesting plan, the employee gets a percentage of the shares they are offered with. To explain better, let us use an example. Let us say that Tom is an employee in Y Inc. Now, due to his hard work, the employer decides to give him equity as compensation. A plan is prepared and the graded vesting schedule is created.
As per the schedule, Tom will have 5 years before he gets all the shares that the company is offering in the plan. But in this case, he does not get them all together. Instead, he will get 20% of the total shares after every year. And on the fifth year, he will have 100% of the shares as per the plan and share vesting agreement.
This plan is different from the cliff vesting plan because if the employee (in the example Tom) decides to leave the company within two years of the graded vesting period, he will be taking 40% of the shares that were awarded with him. The company will not revoke the shares awarded in this plan. And if the employee decides to stay for longer, they will get the benefit of obtaining 100% of the shares as per the plan.
Pros and Cons of Share Vesting
With all the things clear about share vesting and its types, let us talk about the various pros and cons of it.
Here are some of the top-benefits of Share Vesting
- When a company is offering share vesting to its employees, it does not require to involve any cash payouts. It is beneficial for a company as on the company’s books, there would be no outflow of cash. Instead, the company would only offer the employee stock ownership.
- The employees find this offer very lucrative as it allows them to receive the high value of shares in the future. Basically, employees purchase the shares at a discount and after 4 or 5 years when they receive them, the value of the company will have increased and so would the value of the shares. In this case, when the employees sell the shares after they are vested, they may get a large payout.
- If share vesting is a part of the employee contract, it tends to improve the performance & outcome of the employees. It is because of this reason that an employee remains tied to the offered shares for vesting.
- Another benefit of providing share vesting for employees is that it helps to retain an employee, in case they want to leave early. They do not leave as they are aware that they are eligible for reward or a potential gain in the form of shares vested in the future. As a result, they won’t quit early.
- Share vesting for employees is also beneficial for startups. As we know, startups usually don’t have much capital in their business accounts. Therefore, they are not willing to offer higher salaries to their employees. However, a startup has to hire great talents (who demand higher payouts/salaries) to stay ahead of the competition. Thus, by offering shares to be vested, apart from their salary, startups can easily attract such talents.
Not everything is perfect in this world. And just like that, share vesting for employees also has its cons.
Here is a list of some of the major disadvantages of share vesting
- One of the significant disadvantages of share vesting is its tax consequences. The tax consequences depend on the type of share vesting plans as the tax liability changes accordingly. It also depends on the time of your decision based on when you would like to sell your stock option. And that is not all. Stock-based compensation that an employer offers their employees is also taxable.
- Another disadvantage of share vesting for employees is that it takes a long period to be vested, which is normally 3 to 5 years based on the plan.
- Share vesting is not always preferred by some employees. Let’s say an employee desires to leave a company (due to personal reasons) or is fired before the vesting period is completed. In that case, they cannot reap the benefits of the vesting plan. And because of this, some employees tend to avoid taking part in such programs.
How Eqvista Helps to create a vesting plan for your company shares?
Now that you have everything cleared about vesting and its types, you might be thinking of incorporating this plan in your business. Well, in this case, you can easily use Eqvista to create your vesting plans along with tracking your company shares.
Once you have your company account created on Eqvista and your cap table is there, all you need to do is create a vesting schedule for issuing shares to an employee or new shareholder. For creating a vesting schedule, you need to go on the vesting schedule page from the dashboard. Here are the steps to do it:
Step 1: To get here, click on “Cap Table” and then “Vesting Schedule to reach the following page. On this page, click on “Create Vesting Plan.”
Step 2: You will be taken to the next page where you will have to add in the details that will make the vesting plan as shown below. Once you do this, you need to click on “Submit”.
Step 3: And with this, your vesting plan is created on Eqvista. You will be directed to a page where you can see all the plans. And you will be able to see the plan you just created as shown below. You can now begin issuing shares to your employees by using the vesting plan that you just created.
In short, it is very easy to create a vesting plan with Eqvista as shown above. So, what are you waiting for? Let Eqvista help with your vesting plans and electronic shares issuances. Create your profile on Eqvista here and start issuing shares today!