How Does the Vesting Schedule for My Equity Work?

If you have, or plan to receive, any sort of equity compensation then it’s important to know how your vesting schedule works and the concept of “vesting” in general.

Knowing the ins and outs of your vesting schedule can help with your strategic financial planning in order to make the best decisions possible.

What is a vesting schedule?

A vesting schedule is a timeline that determines when the forfeiture restrictions lapse on your equity, or when the equity you’ve been granted becomes yours to do what you wish (sell, exercise, hold, etc.). An employer has “promised” you equity but it only becomes yours after certain “conditions'“ are met.

Vested = yours

Unvested = not yours

Vesting schedules are a strategic way that employers choose to retain employees (i.e. “golden handcuffs”). A substantial risk of forfeiture does exist if you don’t meet the vesting requirements. For example, if you leave your company before your equity vests then you will forfeit the right to it.

Your vesting schedule should be able to be found within your personal grant document(s). I suggest you reference those documents to know exactly what your vesting schedule is.

What are the types of vesting?

Time-Based Vesting

The most common and widely accepted vesting arrangement is time-based vesting. Time based vesting requires a certain length of employment to pass after your grant before your equity becomes “yours” to exercise and/or sell.

It’s important to note that each grant has it’s own specific vesting schedule and may even vary amongst your different equity types (e.g. NSOs, ISOs, RSUs, RS, etc.). This is why it’s important to become familiar with each grant via the grant documents.

Most equity grants will not vest anything immediately or before the first anniversary. This is a form of “golden handcuffs” and is implemented to retain employees.

The are two main time-based vesting methods that are primarily used today: graded vesting and cliff vesting.

Graded Vesting

Graded vesting occurs when your equity gradually vests over a period of time instead of all at once.

For example, let’s say you receive a grant for 4,000 shares of restricted stock that were set to vest annually over four years. You wouldn’t vest anything within the first year after your grant. At your first year anniversary you would vest 1,000 shares. At your second anniversary you would vest another 1,000 shares and so on until you’ve vested the remaining shares.

As you can see below, as you vest more equity over time it creates an upward and steady “grade” or “slope”.

Graded vesting is often used to prevent employees from quitting on a hard date since they would need to work incrementally longer to receive incrementally more of their equity.

Cliff Vesting

Cliff vesting occurs when your entire equity grant becomes fully vested after you meet certain length of employment and/or performance based requirements (if applicable—more on this later).

For example, let’s use the example above but instead your 4,000 shares vest based on a 3-Year cliff.

You would vest:

• 0 shares at grant

• 0 shares after 1 year of employment post grant

• 0 shares after 2 years of employment post grant

• the full 4,000 shares after 3 years of employment post grant

As you can see, the visual below represents more of a “cliff” rather than a “grade”. I also added another example of a shorter one year cliff as an illustration.

It’s important to note that it’s very common to see cliff vesting used with graded vesting in the same grant.

A popular combination is a 4-year vest with a 1-year cliff. This means that after one year of employment, post grant, 25% of your equity would vest and the remaining 75% of your equity would vest over the next 3 years. This remaining equity tends to vest incrementally and proportionately over the remaining timeline (e.g. monthly or quarterly).

Performance Vesting

Performance vesting is a type of vesting that only occurs when certain performance goals are hit.

This vesting typically only occurs with restricted stock and restricted stock units (RSUs) AND is typically only extended to the CEO or senior executives.

Performance targets could include: share-price appreciation, total shareholder return, and hitting specific financial targets.

Acceleration of Vesting

Vesting may be accelerated within an equity plan if certain conditions are met. These conditions include but aren’t limited to:

• qualified retirement

• death

• disability

• or change of corporate control (e.g. merger, acquisition, IPO, change in the board of directors/senior management/substantial shareholder ownership)

Any of these events have the possibility to trigger accelerated vesting. Be sure to review your company’s equity/stock plan documents to know for sure what you’re governed by.

Finally, if you’re employed by a private company you may have a “double trigger” attached to your equity (this is most popular with RSUs). Again please review your plan documents for your equity specifics.

A double trigger means that two triggers need to be satisfied in order for you to vest your equity.

For example, in order for you to vest your equity you may need to satisfy the time-based requirements (1st trigger) AND there would need to be a change in control (2nd trigger) such as an M&A or IPO.

Understanding your vesting schedule, and the provisions of it, is crucial when it comes to managing your equity compensation. Knowing the ins and outs of your vesting provisions allows you to develop a strategic plan around your equity in order to make the best decisions according to your financial plan.

Spend some time getting to know your vesting schedule and provisions or if that’s too overwhelming then hire a financial planner to do it for you!