7 Things to Know About Stock Vesting
When landing a new job in the tech industry, all the details about stock options can seem overwhelming and jargon-filled. Not to worry! We’re here to help with a few high-level things to keep in mind about stock vesting.
1. Your vesting schedule typically starts from your grant date.
When you receive stock as part of your compensation package, the shares are usually subject to a vesting schedule starting from your grant date. This vesting process means that the shares do not immediately become yours.
Instead, you earn the right to own the shares over time as you meet certain conditions, such as working for the company for a certain length of time or achieving certain performance milestones or goals. The vesting schedule is typically expressed as a series of dates or milestones that mark when a certain percentage of the shares become vested.
For example, you might be granted 4,000 shares of company stock, with a vesting schedule that says you'll receive 1,000 shares on the first anniversary of your employment, and another 1,000 shares at each additional anniversary until you’ve fully vested all shares after year 4.
Until the shares are fully vested, they are subject to forfeiture if you leave the company. Once the shares are fully vested, you own them outright and can choose to hold onto them or sell them—regardless of if you stay with the company or not.
2. Vesting schedules are determined by a variety of factors.
Not all companies use the same stock vesting schedule. Companies determine vesting schedules based on various factors:
Industry norms: Companies may use industry norms to guide their vesting schedules.
For example, suppose most companies in the industry use a four-year vesting schedule. In that case, the company may use a similar, calendar-based vesting schedule to remain competitive in attracting and retaining talent. (A typical vesting schedule is usually four years among the tech companies where we have clients today.)
Company Goals: The company's plans for its equity compensation program may also influence the vesting schedule.
For example, suppose the company wants graded vesting to incentivize employees to stay with the company for the long term. In that case, it may use a more extended vesting period with a cliff vesting feature. Alternatively, if the company wants to incentivize employees to achieve specific performance goals, it may use a vesting schedule tied to those goals.
Management Team Preferences: The preferences of the company's management team can also play a role in determining the vesting schedule.
For example, suppose the company's leadership believes that a more extended vesting period will help align the employee compensation incentives with the company's long-term goals. In that case, they may use a more extended vesting schedule.
Some companies may use a cliff vesting schedule, in which employees receive a large portion of their shares after a certain period. In contrast, others may use a graded vesting schedule, in which shares of stock vesting work out gradually over time. The specifics of the vesting schedule should be outlined in the employee's stock plan or employment agreement.
The specifics of a vesting schedule can vary widely from company to company. It's a good idea to review your stock plan and employment agreement carefully to understand your specific vesting schedule and any other conditions that may apply.
3. Vesting periods are used to incentivize & retain long-term employees.
Stock-based compensation can be a powerful tool for aligning employees' interests with the company's goals, and vesting schedules are used to ensure that employees remain with the company and contribute to its success.
Here are some of the reasons why companies use stock vesting:
Retention: Companies want to retain their top employees, and stock vesting can help incentivize them to stay with the company over the long term. By tying stock awards to a vesting schedule, the company can encourage employees to remain with it until their shares fully vest.
Performance: Companies may use vesting schedules to incentivize employees to perform at a high level. For example, the vesting schedule may be tied to specific performance goals or milestones to be met before the shares can vest.
Equity participation: Stock vesting can also help employees feel they have a stake in the company's success. Employees who own shares in the company may be more motivated to work hard and help the company achieve its goals.
Cost savings: Finally, stock-based compensation can be less expensive for the company than cash-based compensation. This is because the value of the stock can appreciate over time, and the company may not need to pay out as much in cash compensation to achieve the same level of employee motivation and retention.
4. Leaving the company may mean forfeiture of unvested shares.
Employees who leave a company before their shares are fully vested will typically forfeit the unvested shares. This means the employee will lose the right to own those shares, which will be returned to the company's stock plan pool.
In some cases, the employee may keep a portion of the unvested shares if the vesting schedule includes a cliff vesting feature.
For example, suppose the vesting schedule has a one-year cliff. In that case, the employee may forfeit all unvested shares if they leave before the first anniversary of their employment but may be able to keep a portion of the unvested shares if they leave after the first anniversary.
Some companies may have different forfeiture rules based on the reason for the employee's departure (e.g., termination without cause vs. voluntary resignation). In contrast, others may have different forfeiture rules for different types of equity awards (e.g., stock options vs. restricted stock units).
5. Accelerated stock vesting could be an option
In some cases, stock vesting can be accelerated. For example, if a company is acquired, the vesting of employee shares may be accelerated to become fully vested upon the acquisition. Additionally, some companies may offer accelerated vesting as a retention tool for critical employees.
6. Tax implications can be very complex.
The tax implications of stock vesting can vary depending on the specific circumstances.
In general, when shares vest, the value of the shares is considered taxable income to the employee. The employee may owe federal and state income taxes on the value of the shares and Social Security and Medicare taxes.
If the employee holds onto the shares and sells them later, they may be subject to capital gains taxes on any appreciation in value. Alternatively, if you were granted stock options instead of RSUs, the vesting milestone may only carry a tax consequence once you exercise your options.
7. Stock vesting can be negotiated.
A candidate may be able to negotiate for a more favorable vesting schedule as part of their compensation package. Additionally, key employees may be able to negotiate for accelerated vesting or other benefits to incentivize them to stay with the company.
For example, we experienced a negotiated milestone-based vesting schedule with several executive-level clients during the 2010s, called a "double trigger." Those clients successfully negotiated for a double trigger on their equity vesting. This means that if the company 1) went public or 2) was acquired, the employee's full stock grant would vest immediately.
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Stock vesting (along with other financial factors) are a big part of the modern tech startup landscape—and can be very confusing to navigate solo.
As always, seeking counsel with a financial planner or tax advisor is suggested to understand your financial goals and options better. These individuals can give you the tax advice you need to make an informed decision about your company shares.
If you’re looking for some extra guidance, we’d love to connect with you and share a bit of what we’ve done for other clients in similar situations!
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