A stock option vesting schedule refers to a schedule of how an employee earns their shares over time. For example, in Silicon Valley, the most popular form of vesting happens each month over a four year time period with a one-year cliff. This means you have the right to 1/48 of those shares that were granted each month over a four year period, or 48 months. However, if you leave the company before your one-year employment date, you won't get anything (known as going over the cliff).

What is Vesting?

This means you earn 1/4 of the stock on your one-year employment date and have an extra 1/48 vested each month after that. If you leave the company after being there for two years, you can exercise half your options. Having a one-year cliff has the purpose of protecting businesses against giving out stock to bad employees, which normally doesn't get recognized until a few months into them getting hired.

Time to exercise shouldn't be confused with vesting. It's required by many companies to use your shares within 90 days of leaving your job and a maximum of 10 years from when they were granted even if you don't leave the company.

What is a Vesting Schedule?

One of the main factors to think about when you set up a stock option plan is to create a vesting schedule. This defines when you can exercise any stock options or if there are forfeiture restrictions lapse on the stock that's restricted. Some companies let new employees have vesting immediately as an incentive for their sign-on bonus. Other businesses form their plans so options will vest over a long period of time, which encourages employees to stay with the company.

The type of vesting schedule that's chosen should take two factors into consideration:

  • How the stock options want to be used (such as to motivate, reward, attract, or keep employees)
  • If you have a non-qualified or qualified stock option plan

Vesting will be figured out for each grant separately. A schedule can be time-based (cliff or graded) if it's necessary to work for a specific period of time before vesting. It can also be based on performance or stock market targets. Sometimes vesting can be accelerated at specific events (such as a death or a merger) or by the board of directors. Your plan should include all these specifics.

If you are given 5,000 shares or stock options of restricted stock and the graded vesting schedule is over a four-year time period, 25 percent of these grants will vest every year. When it's been one year since your grant date, 25 percent of the restricted stock or options vests. When every portion vests, the shares of restricted stock can be sold or you can exercise related options.

Termination will stop vesting with the exception of disability, retirement, or death, depending on what the grant and plan agreement is. In the previous example, if you end your employment with a company three years from the date of grant, you'll give up 1,250 shares that weren't vested yet. For the 3,750 stock options that were unexercised vested, the post-termination rules need to be followed.

Vesting Schedules for Nonqualified Options

Most stock option plans that are broad-based are non-qualified options. These aren't regulated as well as qualified stock options are and let the vesting schedule be more flexible. Companies that have stock option plans that are broad-based have a three- to five-year schedule where a specific percentage of options are vested every year. The most regular schedule has an equal percentage of options vested each year for four years. In the case of qualified stock options, they're given through employee stock ownership plans and get monitored by the Employee Retirement Income Security Act of 1974.

These options make it mandatory that ESOPs have at least one minimum vesting schedule, whether it's graded vesting or cliff vesting. With cliff vesting, the options will vest 100 percent after five years of employment or all together. With a graded vesting schedule, it requires three years of service for employees to become 20 percent vested.

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