Shares Vesting Meaning Examples How It Works Why It Matters

Shares Vesting Meaning

It means shares awarded to employees or founders as a part of the compensation package. It could be a contribution to the pension plan and also as a way to reward and retain them. This sharing by an individual is a process that happens over many years (usually four to five years).

Through share vesting, the company can keep its employees loyal to the company.At the end of such a vesting period, employees can acquire rights over the share or the contribution towards a pension plan.If the founder of a company is given shares for vesting, the terms of the agreement are available in the ‘Shareholder agreement’Shareholder Agreement’A shareholders agreement is a type of agreement that is initiated between a company and its equity holders. The purpose of this agreement is to safeguard the interests of minority shareholders.read more. And if an employee has been offered shares for vesting, the terms are available under the ‘Employee contract.’

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Examples of Shares Vesting

Suppose an employee receives shares vested over four years. It means that a whole lot of this vesting in the company will only be available to the employee after four years. Hence, only after four years, the employee is said to be fully vestedFully VestedFully vested refers to a situation where an investor enjoys full authority and control of every financial instrument (stock options, retirement benefits, profit sharing). It is often followed by a vesting schedule. It is a verified right to the investor and can’t be removed from an outsider.read more.

Let us say that Mrs. A is an employee of Company ABC. She receives an option to buy 1,000 shares of her employer, who is Company ABC. However, these 1,000 shares cannot be vested in one go. They will need to be vested equally for four to five years. Mrs. A will only be able to exercise her stock optionsStock OptionsStock options are derivative instruments that give the holder the right to buy or sell any stock at a predetermined price regardless of the prevailing market prices. It typically consists of four components: the strike price, the expiry date, the lot size, and the share premium.read more after she is fully vested, which is after four to five years.

source: cnbc.com

A classic example from the world of business, often cited, is that of an artist. He worked on the office space for Facebook when it was only a year-old start-up company. For his work done for the interiors of the office space, the artist chose to take shares of Facebook and not his entitled cash compensation. When Facebook first went public with its initial public offering in the year 2012, the artist’s shares are said to be valued at around $200 million.

Advantages of Shares Vesting

Disadvantages of Shares Vesting

Besides the many benefits of vesting in shares, one major disadvantage is that tax cBesides the many benefits of vesting in shares, one major disadvantage is that tax consequences are depending on the types of shares vested, tax liability changes. Taxes may also apply depending on when you choose to buy and sell your share or stock option. Similarly, if a company gives vesting shares as a stock award, the income given stock-based compensationStock-based CompensationStock-based compensation also called share-based compensation refers to the rewards given by the company to its employees by way of giving them the equity ownership rights in the company with the motive of aligning the interest of the management, shareholders and the employees of the company.read more for performance is liable to be taxed.
Another disadvantage is that an employee does vesting on a long term basis. The benefit of vesting shares accrues to the employee only after four to five years, i.e., once he is fully vested.Recently hired employees may not receive the benefit of it as there exists a cliff period. We will discuss it in the next section.If the employee leaves the company or company fires him before the schedule completes, he will be unable to avail of the complete benefits of vesting

Limitations

There is a concept of a cliff period that must be discussed here as a limitation of shares vested. A cliff period is a period when the company doesn’t allot any share to the employee. It is usually a cooling-off period right after an employee joins a company. This period could range from a few months to one year. After an employee completes the cliff period, he can own shares for vesting. The cliff period exists to account for any risks that may arise during the initial few months or years of a start-up or recent hiring. These risks could involve a founder of the company quitting during the initial stages of the start-up. Or an employee quitting within the first few months.

Shares Vesting Meaning Examples How It Works Why It Matters