by: Achaessa James, CEP/PMC
Now that we’ve answered the first three questions in the first blog in this series about the type of stock option, the employee status of the recipient, and the exercise price vs. grant date fair market value (FMV), the next most important question is:
What is a Vesting Schedule?
The vesting schedule describes the requirements which must be met in order to earn the rights described by the equity award. A vesting schedule can be applied to any type of equity award—options (the right to purchase stock at a later date for the stock’s FMV on the option grant date), restricted stock awards (the right to receive or purchase stock), Stock Appreciation Rights (the right to receive the difference in the FMV value of stock on the grant date and on the payout date), phantom stock awards (the right to receive the FMV of the stock on the grant date, plus any appreciation, at a later payout date), and performance-based awards (the application of performance goals to one of the above award types).
The Elements of a Vesting Schedule
- The vesting start date. The date at which the recipient starts earning the award.
- The type of vesting schedule.
- Strictly time-based. The award is earned over a period of time that only requires continued engagement.
- Performance based. The award is earned by achieving performance goals that are dependent upon the recipient’s or the company’s achievement of performance milestones.
- Market-based. The award is earned when factors controlled by the public market are achieved, such as a specific stock price.
- Is it a combination of vesting types? Yep, these can get complicated.
- The incremental vesting segments.
- Single segment. The award vests 100% at the end of the vesting period.
- Equal periodic segments. The award vests in equal installments across the vesting term (annually, quarterly, or monthly).
- Cliff vesting followed by periodic segments. The award vests one chunk after a large period of time (the cliff) and then equal periodic segments after the cliff.
The most common type of vesting schedules for options are time-based over three to five years, with four years being the most commonly used. For public companies, the vesting is usually equal periodic segments over the vesting term—like equal annual or quarterly segments. For private companies—especially those in the technology industry—the most common is cliff vesting, with 25% of the award vesting after one year, and then the remainder vests in equal monthly installments for the last three years. As each time period is completed by the award recipient, the award can then be exercised for the number of shares that are vested.
But what happens if the award recipient doesn’t complete the vesting period? Or what if the recipient takes a leave of absence? Just like every other employment benefit, equity awards are affected by employment status and we’ll answer those questions next month in Admin Super Powers.
Achaessa James has worked in equity compensation since 1999 in the legal, venture capital, and equity administration outsourcing fields. She is a senior Equity Compensation Consultant with Stock & Option Solutions where she supports clients with system implementations, data migrations, corporate governance audits, corporate transaction preparation, and special project design and implementation. She is also the consulting Equity Compensation Product Manager for the National Center for Employee Ownership where she manages the highly regarded twice-yearly CEP Exam Prep Course, and serves as the NCEO’s subject matter expert on equity compensation.
Achaessa’s focus on privately held companies has earned her a deep expertise in pre-IPO and M&A equity planning and audits, and best practices in administration and technology. She speaks on these topics at industry conferences and in webcasts, and is a published author with books including “If I’d Only Known That!”, and “The Private Company Equity Compensation Administration Toolkit” as well as many newsletter articles in industry publications. You can connect with Achaessa on LinkedIn.