Stock-based compensation is widely accepted as an effective way to retain talent within organizations. However, if employees could convert stock options into equity instantly, then ESOPs and other forms of stock-based incentive plans would be rendered ineffective when trying to retain employees. That’s why stock options follow a predefined ‘vesting schedule’.
Vesting is an incentive program for employees, allowing them to increasingly earn a portion of the stock options offered to them based on their employment tenure or goal-based milestones.
Types of vesting
There are multiple types of vesting schedules: time-based, milestone-based, immediate, and a hybrid of time and milestone.
Time-based vesting: Time-based vesting is when employees earn options over a specified period of time. A typical vesting schedule is four years with a one-year cliff period. A cliff is the period of time before any options can start to vest.
An analysis of our customers’ vesting schedule shows that ~81% of companies use a four-year vesting schedule, followed by ~12% using a 1-year vesting schedule and ~8% using a three-year vesting schedule.
Similarly, ~95% of companies registered on EquityList to manage stock options use a one-year cliff period.
- Milestone-based vesting: Milestone-based vesting is based on achieving pre-decided targets. These milestones may vary from reaching a business goal to the company’s valuation to product-specific revenue or more.
- Immediate vesting: There are certain hires a company may need to do for a business objective. In such edge cases, depending on the importance of the role and the seniority, the company may allow immediate vesting.
- Hybrid vesting: Hybrid vesting is a mix of time and performance-based vesting. Here, an employee may need to fulfill a particular time within the company and achieve pre-decided milestones to vest the options.
How does vesting work?
Vesting works in a pre-decided schedule.
Typically, the employees must fulfill certain conditions, such as a specified service period with the company or milestones like employment tenure or performance metrics, before exercising their ownership rights.
The vesting schedule is the period over which employees gain ownership of the offered stock. Typically, founders and board members of the company decide the vesting period.
There are several benefits of setting up a vesting schedule, which includes:
- Shares are awarded gradually over time to safeguard company investment and investors.
- Vesting also helps manage potential dilution by safeguarding shares from employees who leave the business on bad terms.
Our data shows that 47.5% of the companies use a quarterly vesting period, while 27.6% use a yearly vesting period. The vesting period is crucial for time-based vesting.
Is there a unique vesting plan for each grant?
Not necessarily; however, a company can customize grant-level vesting. On the EquityList dashboard, admins can quickly manage manual or bulk uploads of grants with the same or different vesting periods.
For instance, advisors are sometimes offered a two-year vesting period with no cliff.
Once the vesting period ends, the employees earn the right to buy company shares.
Are you confused about what vesting period fits your company’s needs? We are here to help. Reach out to us here!
Stay tuned for the next blog!