What it means
Employers grant equity and pension contributions to retain people, so the value is usually released in stages rather than all at once. Vesting is the schedule that governs that release, and fully vested is simply the end point of the schedule.
The most common structure in growth companies is four-year vesting with a one-year cliff. Nothing vests at all in the first twelve months, then a quarter of the award vests in one step, and the rest vests in equal monthly slices over the remaining thirty-six months.
Being fully vested matters because it changes the economics of leaving. An employee eighteen months into a four-year schedule walks away from more than half their award, whereas a fully vested employee has nothing left to lose by moving.
The same language applies to retirement plans, where employer contributions may vest gradually over a set number of years of service while the employee's own contributions are theirs from day one. Cliff vesting and graded vesting are the two usual patterns, and the plan documents decide which applies.
Vested does not always mean liquid or exercised. A fully vested share option still has to be exercised by paying the strike price, and in a private company there may be no market to sell into until an exit occurs, so people can be fully vested and still hold something they cannot spend.
In practice
Real-world examples.
Example
A product manager at a payments start-up reaches month 48 of her option schedule and becomes fully vested in 12,000 options. She now negotiates a new grant, because the retention effect of the original package has run out.
Example
A civil engineer leaves a consultancy after three years under a five-year graded pension vesting schedule. He keeps his own contributions in full but forfeits 40% of the employer contributions because he was not yet fully vested.
Example
A co-founder with a four-year schedule agrees to accelerated vesting on a change of control. When the company is acquired in year three, the acceleration clause makes her fully vested at completion rather than eighteen months later.
Formula
Calculation
Vested units = Total award x Proportion of the vesting period completed, subject to any cliff. Value on exercise = Vested options x (Market price - Strike price).
An employee is granted 4,800 share options with a strike price of $2.00, vesting over 4 years with a one-year cliff, then monthly.
At the cliff, after 12 months, 4,800 / 4 = 1,200 options vest in one step.
The remaining 3,600 options vest evenly over 36 months, which is 3,600 / 36 = 100 options a month.
After 30 months in total, vested options = 1,200 + (18 x 100) = 1,200 + 1,800 = 3,000, or 62.5% of the award.
After 48 months the employee is fully vested with all 4,800 options. If the shares are then worth $11.00 each, exercising costs 4,800 x $2.00 = $9,600 and delivers shares worth 4,800 x $11.00 = $52,800, a pre-tax gain of $52,800 - $9,600 = $43,200.Case study
Seen in the real world.
Bellweather Analytics is an illustrative, fictional data business that granted its first twenty employees options over four-year schedules. In its fourth year, seven of those employees became fully vested within the same quarter, holding a combined 96,000 options at a $1.50 strike against an internal valuation of $9.00.
Three of the seven resigned within four months, taking roughly $720,000 of paper value with them and leaving gaps in the engineering team. Nothing improper had happened: the awards had simply finished doing the job they were designed to do.
The illustrative response was a refresh policy, under which employees receive a new grant at the halfway point of their existing schedule so that there is always unvested value ahead of them. Bellweather also began reporting a vesting cliff calendar to the board a year in advance.
Watch out
Common mistakes.
- Treating fully vested and exercised as the same thing. Vesting gives you the right to buy or hold the shares, while exercising is the separate act of paying the strike price to get them.
- Assuming a fully vested option is safe forever. Most plans give leavers a short window, often 90 days, to exercise vested options before they lapse entirely.
- Ignoring the tax point when the vesting date arrives. Restricted stock units are frequently taxed as income at vesting, so being fully vested can create a tax bill long before any cash is received.
Questions
People also ask.
What is the difference between cliff vesting and graded vesting?
Cliff vesting releases the whole tranche at a single date, while graded vesting releases it in slices across the period.
Can an employer take back fully vested equity?
Only in narrow circumstances set out in the plan, such as a clawback for fraud or a breach of restrictive covenants, and not simply because the employee resigns.
Does vesting continue during a notice period or gardening leave?
Usually yes until the employment formally ends, which is one reason leaving dates are negotiated carefully around vesting dates.
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