Vesting Equity: Everything You Need to Know
Vesting equity is when you claim or assign future earnings, assets, or payments. It is often used by employees in lieu of stocks or options from their employers. 3 min read
Vesting equity is when you claim or assign future earnings, assets, or payments. It is often used by employees in lieu of stocks or options from their employers. For example, vesting equity could come in the form of retirement plan benefits for employees.
After working for several years, an employee will have rights to specific employer-provided assets, providing an incentive to stay with the organization. The longer an employee is at an organization, the more non-forfeitable rights than accrue.
Why Vesting Is a Good Idea
Vesting is more than just a fallback for employees. It also helps entrepreneurs protect their assets in times of disagreement.
For example, pretend you have an idea and want to start a company with a co-founder. Things are going great, until your partner decides to leave the venture unexpectedly. Instead of shutting things down, you continue to go it alone, eventually building up your company to the point where it's worth $300 million. You decide to cash out and sell.
Suddenly, your old partner contacts you and claims he deserves 50 percent of the sale price. Unfortunately, unless you developed a vesting system, he may be entitled to it.
When you start a company with a partner, you're both automatically 100-percent vested. Unless you took advantage of this and purchased his share of equity when he left the company, you may have to pay up when you sell the company. Otherwise, he would no longer have any right to profits earned from the sale of the company.
Types of Vesting
There are three main types of vesting:
- Immediate vesting — In this system, employees are 100-percent vested as soon as they start working for the company. This system is rarely used.
- Cliff vesting — In this system, employees get 100 percent of their equity at one time, but it isn't as soon as they start. Instead, it will be after a certain number of years of service.
- Graded vesting — In this system, employees get their equity in small increments over a longer period of time. This is the most popular system, as it gives employees motivation to stay until they are 100-percent vested.
Vesting Period Examples
One typical approach is to use a four-year vest period. This approach gives employees retention grants after they've been employed for two years. Overall, this approach is good because no employee is ever more than half vested on his or her equity. For example, if you earned up to 50-percent equity and decide to leave after four years, you will only be able to maintain 25 percent.
In this system, your equity vests on a yearly basis. This means that if you decide to quit before reaching a full year, you will not have any equity. If you quit a year and a day after your work anniversary, you'll have one fourth of your total vestment.
Other employers enjoy using a three-year vest period. This lets them give employees retention grants when they are fully vested.
If your employer offers various vesting options, the most important thing to consider is the number of options or stock that you can vest every year. Obviously, the size of the grant is crucial, but it's not the most important factor. You should look most closely at your equity-based compensation amount.
Vesting in Wills
Workplaces aren't the only place where vesting is common. They also occur frequently in wills and bequests. Often, people use vesting to initiate a waiting period after death so that arguments and other issues can be settled.
Sometimes, heirs get into feuds over who should inherit what. Even worse is what happens if the heirs die along with the original testator.
The waiting period allows these matters to be settled, so everyone inherits what is rightfully theirs.
Vesting and Startup Companies
Vesting works a little differently when it comes to startup companies.
Often, employees will have the choice of common stock or a stock-option plan as part of their initial compensation packages.
Because turnover might be high at a startup, companies generally create a vesting period so that employees cannot sell their equity for a certain amount of time.
If you need help with vesting equity, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.