Shares Vesting

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).

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Source: Shares Vesting (wallstreetmojo.com)

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.

Shares Vesting example

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

  • 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

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.

Conclusion

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 –

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