This webiste provides information how vesting works, why it is important in the context of ESOP and VSOP as well as different types
Dominik Konold CEO/founder of Findiy GmbH, specializes in banking and corporate finance. With a background in audit and investment banking, he's a certified Professional Risk Manager and also serves as a lecturer in banking and accounting.
What is vesting and how vesting works
Vesting refers to the process by which employees earn the right to own the grants allocated to them as part of the employer contribution in terms of a share-based payment plan. In simpler terms, it is the mechanism that determines when employees actually gain ownership of the grants.
In contrast to a retirement plan all ESOP/ VSOP require vesting
Vesting schedule
Vesting period
Understanding vesting and types of vesting schedules
In the following part we describe different types of vesting, how they differ and what factors determine the vesting. Understanding the different types of schedules is essential for both employers and employees, as they dictate how and when these benefits are acquired. In this chapter, we will explore various vesting schedules, how they work, and their implications on long-term financial planning. Whether you’re an employee looking to navigate your compensation package or a business owner structuring equity rewards, a clear grasp of vesting schedules is vital for informed decision-making.
There is no such thing like common vesting for stock options
Pro rata vesting conditions
Cliff vesting conditions
This typ of vesting involves a single, specific date on which employees become eligible for a percentage of their
options. Until that date, they have no vested options.
Example: An ESOP might have a three-year cliff vesting schedule. This means employees have to remain with the company for three years before any of their options become unforfeitable. After the third year, all options granted on the grant date become fully vested.
Performance-based vesting conditions
Milestone vesting conditions
Milestone-based vesting is similar to performance-based vesting but focuses on specific company milestones or events rather
than financial metrics.
Example: An ESOP might include milestones such as achieving a successful product launch, reaching a certain customer acquisition number, or expanding into a new market. When these milestones are reached, the associated options vest.
Graded vesting
Rateable/linear vesting conditions
A Ratable schedule involves a straight-line approach, with options vesting incrementally on a monthly or quarterly basis.
Example: An ESOP with ratable vesting may grant options over four years with 25% each year. This means that for each month an employee remains with the company, they earn 1/48th (25% divided by 12 months) of their options.
Immediate vesting
Good and Bad Leaver in the context of vesting
The Good Leaver and Bad Leaver principles are used in the context of equity compensation plans, particularly when an employee departs from a company before fully vesting in their benefits (such as stock options or shares). These principles determine how much of the unvested equity the employee is entitled to retain based on the circumstances of their departure.
Good Leaver
A Good Leaver is typically an employee who leaves the company under favorable conditions, such as retirement, death or disability
redundancy (layoffs due to restructuring), mutual agreement with the company departure after fulfilling most or all service or performance conditions.
In such cases, the employee is often allowed to retain a portion or all of their unvested equity. The specific terms vary depending on the company’s plan, but common outcomes include pro-rata vesting or accelerated vesting.
Bad Leaver
A Bad Leaver is an employee who departs under unfavorable circumstances, such as resignation without good cause, termination for cause (e.g., misconduct, breach of contract, poor performance).
A Bad Leaver generally forfeits all unvested equity, regardless of how long they have been with the company. In some cases, they may also be required to return already vested shares or options, depending on the severity of the cause for termination.
Key considerations
The Good Leaver/Bad Leaver distinctions are typically outlined in employment contracts or equity award agreements. These provisions are designed to incentivize loyalty and performance while protecting the company from rewarding employees who leave under negative circumstances. In the case of private companies, especially start-ups, Bad Leaver provisions are stricter to safeguard equity distribution. Ultimately, these principles create a structured approach to determine how an employee’s exit impacts their unvested equity.