What is a vesting schedule?
Employee share schemes allow employees to obtain shares within the company/business in which they work. Vesting means that employees do not obtain their shares or the right to receive value from them outright but over time (e.g. this is when a right to acquire shares crystallises or where a risk of forfeiture no longer applies). In some cases, this can be over a period of months or years (in the US, for example, many businesses have vesting schedules whereby a number of shares vest monthly over the period of three to four years). Vesting of shares can also be tied to performance conditions. In this scenario, an employee’s shares will only vest once pre-determined performance conditions have been met. In other cases, awards only vest on a major corporate event like a sale of a business – this can be a simpler solution if this aligns with the objectives of the business.
A vesting schedule is normally contained at the end of a share award or option agreement or set out in other documents like articles of association and outlines exactly when, and how many shares will vest. Employees should be mindful of this schedule to understand when their ownership of the shares will take place.
How does it work?
Vesting schedules come in different shapes and sizes but the standard structure is as follows:
Grant date/award date: this sets out the date in which the award or option itself is granted to an individual or shares that are subject to forfeiture are received by an individual.
Vesting commencement date: this is the date on which vesting begins. This can be the date of grant but is often treated as running from an employee's start date – it's important to note that the grant of the option isn't back dated, it's the vesting arrangements that give credit, from grant, for time already running on any agreed vesting schedule. That said, it's still important for other reasons to grant the award/option without undue delay.
Vesting duration: the period in which an individual obtains complete ownership of their shares. It is at the discretion of the employer to decide how often vesting occurs, the number of shares that vest each time, and the duration.
If certain conditions are not met (e.g. the individual ceases employment or does not meet pre-determined performance conditions) the vesting is likely to stop, and the individual may lose their right to some or all of the unvested shares.
Vesting is only part of the story since one of the advantages of share option arrangements in particular is that (unless other conditions have been imposed before individuals can acquire their shares) vesting represents a right (but not an obligation) to acquire the shares. In other words, the option holder can choose when to acquire the shares (and pay any purchase or exercise price).
Why is it important?
Vesting provisions are important because they set out a timeline of when an employee will obtain full ownership of their shares. It’s crucial that an individual fully understands what they will be entitled to receive and over what time period.
Additionally, vesting schedules are a great way to incentivise and motivate employees to stay at a company. As their shares will vest over several months/years, they will be more inclined to continue working at the business if they know that they will be rewarded with more shares in the long run.
Having performance conditions (in addition to vesting schedules) can ensure that employees are incentivised to meet certain other milestones or targets.
How can Shepherd and Wedderburn help?
If you are considering whether an employee share scheme is the right approach for your company, or would like further clarification on vesting provisions, please do not hesitate to contact our experienced team of share plan practitioners who can talk you through the alternatives and help create a tailored share scheme for your business. Like any share incentive arrangement it's important to get the right advice to guide you through the process and take advantage of the various design flexibilities on offer.
This article was co-authorised by Trainee Taylor Foster.