Vesting – What are Vested Options and Schedules?

Vested stock options are relevant to equity grants whereby companies offer their key employees equity as a part of compensation package. This grant has to vest first before getting monetised by the employee. Vesting is the process of earning the stock, whereby the employee receives ownership of the stock over a fixed period of time or, in some cases, after the company hits a milestone.

In India, ESOPs can only be granted to full-time employees, and not to part-time employees, advisors, or consultants, who can be granted non-statutory stock options. In addition, ESOPs cannot vest in the employee within one year of their granting, as there is a mandatory one-year cliff.

Think of a cliff as a standstill period or a moratorium during which no vesting can take place. After the cliff, the stock options gradually vest over an agreed-upon period of time.

If an employee has received an options grant, he/she must carefully read through the company’s ESOP scheme document, grant letter, etc to understand his/her rights and restrictions. The plan decides how and when the owners and employees gain access to or keep their shares.  

There might be instances where new startup founders promise ESOPs to employees when they join, this is typically a verbal commitment or might even be captured on email – that’s about it. But this is by no means enough to actually get started because the vesting of options cannot take place unless all the ESOP related paperwork such as scheme documents, vesting schedule, and board/AGM approvals are in place. Also, typically an ESOP pool itself is created only after the first funding round and it’s from this pool that the actual vesting of grants can take place. 

Uniform Vesting

If an employee is granted 10,000 options with 25% of them vesting per year for four years with an exercise period of 10 years, the employee will have the right to exercise options and have the right to buy 2,500 shares after one year from the option grant date. 

The next 25% would vest two years from the grant date, and so on. If the employee decides not to exercise all 25% vested ESOPs after year one, there would be a cumulative increase in exercisable options. Thus, after year two, the employee would have 50% vested ESOPs. 

Bullet Vesting

If the grant of promised ESOPs gets delayed, bullet vesting is a process that founders can look at. Bullet vesting can be done after the ESOP paperwork (scheme, etc.) gets approved. Essentially, bullet grants work in a single shot, and vesting is not staggered but completed in one instance itself.

Performance-Based Vesting

In business verticals with high churn rates, where expecting employees to stay loyal for years isn’t feasible, a Performance Based Vesting plan can attract top talent as well as act as a sop to get the best out of employees. 

Since the Vesting Plan is tied to the performance of the employee or the performance of the company, i.e., the collective performance of individuals, it keeps employees on their toes to give their best to the company to achieve the conditional predetermined goals.