Vesting of shares: Overview, definition, and example
What is vesting of shares?
Vesting of shares refers to the process by which an employee, founder, or other recipient gains full ownership of shares in a company over a specified period of time, often tied to continued employment or meeting certain performance milestones. In other words, vesting means that the individual does not own the shares outright from the moment they are granted but instead acquires them incrementally over time according to a predetermined schedule. This process is commonly used by companies to incentivize employees, especially in startups or early-stage companies, ensuring that employees remain with the company and contribute to its success before fully owning the shares.
There are typically two main types of vesting:
- Time-based vesting: Shares vest over time, often according to a specific schedule (e.g., monthly or annually over four years).
- Performance-based vesting: Shares vest once certain performance targets or goals are met, such as achieving sales targets or other business objectives.
Why is vesting of shares important?
Vesting of shares is important because it aligns the interests of employees or recipients with the long-term success of the company. It encourages employees to stay with the company for a longer period and contribute to its growth and performance. For companies, vesting serves as a retention tool, ensuring that key talent remains committed to the company and its goals.
For employees or recipients, vesting offers the potential for financial gain if they stay with the company and help it succeed, but it also provides protection for the company, as employees who leave early may not receive the full benefits of the shares. This arrangement is common in employee stock option plans, founder agreements, and other equity-based compensation packages.
Understanding vesting of shares through an example
Imagine a startup offers an employee 1,000 shares in the company as part of their compensation. The shares are set to vest over four years with a one-year cliff. This means that the employee will not own any shares until they have worked with the company for one year (the cliff). After the first year, 25% of the shares (250 shares) will vest. After that, the remaining shares will vest in equal monthly installments over the next three years. If the employee leaves the company before the end of the four years, they will only keep the shares that have already vested.
In another example, a co-founder of a company is granted 10,000 shares, with the shares vesting based on the achievement of specific business milestones. For instance, 2,000 shares may vest when the company raises its first round of funding, and additional shares could vest upon hitting revenue targets or other key performance indicators (KPIs).
An example of vesting of shares clause
Here’s how a vesting of shares clause might appear in an agreement:
“The Shares granted to the Employee shall vest in accordance with the following schedule: 25% of the total number of Shares shall vest on the first anniversary of the Employee’s start date (the 'Cliff'), and the remaining Shares shall vest in equal monthly installments over the next 36 months, provided that the Employee continues to be employed by the Company at each vesting date.”
Conclusion
Vesting of shares is a powerful tool used by companies to incentivize employees, align their interests with the company’s success, and retain key talent over time. Through time-based or performance-based vesting schedules, companies ensure that employees contribute to the company’s growth before fully benefiting from equity compensation. For employees or recipients, vesting represents an opportunity to gain ownership in the company, but it also comes with the requirement to stay committed and achieve certain milestones. The vesting of shares is a crucial part of many compensation plans and plays an important role in business strategy and employee retention.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.