Shares vesting refer to the grant of shares over a pre-decided tenure as the compensation package or contribution towards the pension scheme to the employees or to the founders of the company to reward them for their work performance and to retain them for longer years in the company.
Shares Vesting Meaning
It means share 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 shares 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’. And if an employee has been offered shares for vesting, the terms are available under the ‘Employee contract.’
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 vested.
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 options after she is fully vested, which is after four to five years.
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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
- Whenever a company offers shares vesting to its employees, it is very beneficial to the company. As it does not involve any cash payout, there is no outflow of cash on the company’s books. It simply means the company is offering the employee stock ownership of the company.
- It is also very beneficial to employees as it puts them in the position of receiving high value for their shares, as in the case of Facebook.
- When companies include share vesting as a part of the employee contract, it leads to improvement in the performance of the employee. As the employee’s performance is tied to shares offered for vesting, the employee has an inherent incentive to perform well.
- It also helps with employee retention. When employees know that there is a potential gain or reward in the form of shares vested in the future, they stay in the company for a longer time.
- Further, when start-ups do their hiring, the salaries of employees are considerably low. By offering shares to be vested, the employees get additional benefits apart from their pay.
Disadvantages of Shares Vesting
- Besides 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 share as a stock award, the income given as stock-based compensation 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.
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.
It is a very beneficial instrument for both companies and employees. By incentivizing employees to perform better, the business interests of the company continue to stay alive. Employee retention is higher, and so is their motivation to work towards the goals of the company. For the company, it allows for less hassle with hiring new employees as they stay for the long term due to the potential rewards through shares vested. It also safeguards the company’s shares as the existence of a cliff period does not allow early leavers of the company to benefit from them.
This article has been a guide to what is Shares Vesting and its meaning. Here we discuss Share Vesting examples, advantages, disadvantages also its Limitations. You can learn more about accounting from the following articles –