What is vesting?

If you’re reading this, the chances are you’ve recently enrolled on a company share scheme. Be it share options or growth shares, it’s exciting stuff!

But before you dream of cashing in, there’s something you need to know. It’s unlikely you’ll get your hands on them straight away. They’ll need to vest first. 

Confused? Not for long. This guide explains what vesting is, how it works and what it means for you.

What is vesting?

Vesting, in its simplest possible terms, is how you ‘earn’ your shares/options.

You might receive them over time or when you achieve certain goals. This means you need to meet specific conditions to get your full amount.

OK, but why? 

The purpose of vesting

Incremental vesting incentivises people to stick around. The longer you stay with the company, the more shares/options you’ll unlock. It’s a long-term incentive and motivational tool.

Vesting, along with protections like leaver clauses, also gives the business that critical reassurance that everybody who gets equity, truly earns it.

Share option vesting

If it’s a share option scheme or employee stock ownership plan (ESOP) you’re a part of, your options will probably vest over time. And there may be additional criteria too like performance-related targets.

Once those options have vested, as long as you uphold your end of the bargain (stay with the company, usually) you’ll hold onto your options until they’re ready to exercise, or in other words, buy.

Exercising is the process of converting your options into real shares. 

It’s very rare to award options without conditions attached to the vesting. There are also exceptions and ways to speed things up (like immediate vesting) which we’ll come onto, but that’s one for your employer.

There are different rules for different schemes too. Below is a breakdown of the most popular share option schemes in the UK and the key things to be aware of.

Enterprise Management Incentives (EMIs)

If it’s an EMI scheme then count yourself lucky! It’s the most tax-friendly option scheme by far.

EMI options usually aren’t available immediately, they vest. When the vesting schedule is complete, that means your full allocation of options has vested. Sweet!

However, when you can exercise those shares entirely depends on whether the EMI scheme is exit-only or exercisable.

To make the most of all the tax advantages the EMI scheme has to offer, you must: 

• Hold the equity (either as an option or once exercised) for at least 24 months in total (from the day of grant) before the shares are sold.
• Exercise your vested options within 90 days of a disqualifying event.
• Exercise your vested options within 10 years of being offered them.

Other factors come into play should you decide to sell the shares. We cover all of this and more in full in The Joy of EMI Option Schemes, which you can download for free.

Company Share Option Plans (CSOPs)

Like every option scheme, CSOP options can vest too. CSOPs are pretty tax-savvy as well, providing that:

• You exercise your vested options between three to 10 years after the options grant date.

Basically, there’s a seven-year window to benefit from the tax relief this scheme offers, and it starts three years after the company grants the options.

For more details, download CSOP Essentials.

Unapproved share options

There’s nothing dubious about ‘unapproved’ options; they just don’t have the tax advantages that EMI options and CSOP options do. 

Again, unapproved options vest. And in certain situations, VAT is due when that happens. 

The tax implications for unapproved options are a little more complicated than that, but we break down everything there is to know here. 

Growth share vesting

Growth shares are real shares as soon as they’re issued. The moment you accept them they’re yours - there’s no exercising involved. But you still might have to wait to get your hands on them.

More often than not, growth share schemes have vesting schedules, to incentivise individuals like you over time.

Once growth shares vest, they can’t be deferred (cancelled), in other words, you get to keep them so long as you fulfil the conditions of your agreement.

Growth shares are unlike any other type of share or option for that matter, because they’re issued at a hurdle rate. We won’t get into this now, but you can download our free Beginner’s Guide to Growth Shares if you’re interested.

Restricted Stock Units (RSUs)

RSUs are granted as shares, which means they’re taxed as income. And that tax is payable every time they vest. Until the RSU vests, it has no tangible value. As well as a vesting schedule, RSUs can be conditional, so in that way, they’re similar to options, but certainly not the same thing.

What’s a vesting schedule? 

A vesting schedule outlines when you’ll earn your allocated shares or options. Usually, it’s split into tranches and spans a few years.

Vesting schedules come in different shapes and sizes, but more often than not, they’re time-based. One thing’s for sure, the vesting schedule should be crystal-clear to you.

Why create a vesting schedule?

With a vesting schedule in place, the company can: 

• Make sure shares go to those who are genuinely committed to the company’s long-term success.
• Reward you for staying with the company or hitting key targets.
• Protect existing shareholders' interests - if their equity is to be diluted (for anything other than investment) it had better be for a good reason, ie., rewarding people like you for your hard work and dedication.

And not for what you’ll say you do, but for what you actually do. Add value to the business and you’ll be rewarded. 

Vesting schedule example

A typical vesting schedule may look like this: 

• Four-year vesting period with a one-year cliff with annual vesting thereafter. 
• Once the one-year cliff is out of the way, 25% of your allocated options will vest each year, often on your ‘work-versary’.

Let’s say you’re awarded 5,000 EMI options in total. Using the example above, here’s how those options would vest:

Things to look for in a vesting schedule

Vesting is a win-win. You’re rewarded for your contributions over time and the company benefits from your loyalty.

But vesting schedules only work if they’re clear, easy to understand and fundamentally, fair.

1. Clarity

It’s crucial that you fully understand how your shares/options will vest, what will happen if you leave the company (aka leaver clauses) and what rights you have. If that’s not clear, wave a flag.

2. Simplicity over complexity

If you’re overwhelmed by the sheer number of performance-related conditions tied to your shares/options vesting, or they’re confusing, unreasonable or unattainable, push back.

3. Duration

Vesting schedules are usually four, five or six years (max). A longer vesting schedule might make sense, depending on the nature of the business (maybe the customer buying cycle is long). Whatever the reason, make sure you’re fully on board with it.

4. Liquidity opportunities

A share scheme that doesn’t offer you the chance to cash in your shares at some point is pretty pointless (and unethical) unless there are other benefits like dividends.

Each class of shares may have different rules, and it’s important to know if your shares entitle you to dividends. For example, growth shares can receive dividends, but only if it’s specified in the company’s Articles of Association.

If the scheme lacks both liquidity and dividends, there’s nothing in it for you.

Types of vesting

Shares and options can vest in different ways. Over time with a cliff the norm, but there's also:

• Accelerated vesting
• Performance-based vesting
• Back-weighted/backloaded vesting
• Reverse vesting
• Hybrid vesting
• Immediate vesting

Let’s run through each of them in case they crop up. 

Time-based vesting

A time-based vesting schedule should make it clear whether your shares or options will vest annually, monthly or quarterly, and for how many years. Like in the example we shared.

75% of our customers choose time-based vesting for their company share schemes.

Four years is pretty common in the UK and across the pond. The company you work for may design a shorter or longer schedule (within reason) depending on their specific needs. 

Cliff vesting

A cliff is a period of time between the vesting start date and when the options first begin to vest. A period of nothing before something. Usually, it’s 12 months but it doesn’t have to be.

58% of our customers that add a cliff, choose a one-year cliff.

Adding a one-year cliff to the start of a vesting schedule makes sense for options that vest annually and for new starters.

On average, it takes at least 12 months for a new employee to be fully productive in their role. And more than one-third of newly hired employees leave before then.

So in that respect, you can think of a one-year cliff a bit like a probationary period. If you leave within a year, you leave with nothing. But once you pass that 12-month mark, you’ll start earning your options.

Accelerated vesting

Accelerated vesting is when your shares or options vest faster than originally planned, so you don’t lose out on the options you haven’t earned yet.

This can happen in certain situations, like if the company is acquired or you leave under specific circumstances; redundancy could be one of them.

You can see the appeal, but there have to be clauses in your share/option agreement that make this possible, and even then, the decision lies with the board of directors (unless they pre-agreed to it).

Performance-based vesting

Instead of (but usually as well as) time-based milestones, the vesting of your shares or options may be tied to performance-related conditions. Think KPIs, sales targets - that sort of thing. 

For example:

• Generate £X in sales by XX/XX/XX
• Deliver client work valued at £X or above
• Profit goal reached
• Secure £X of funding
• Deliver an agreed project by XX/XX/XX

We totally get it but performance targets can be tricky, unless they’re very specific, measurable and, most importantly, achievable. And let’s be honest, the fewer targets, the better! 

Back-weighted vesting

You could be awarded a greater percentage of your allocated options in the later years of your employment. It’s called back-weighted or back-loaded vesting.

Let’s say you hit peak performance in your fourth year of employment. You’re contributing more and possibly working harder than ever.

However, under a traditional vesting schedule, you'd still receive the same percentage of shares vesting in year four as you did in previous years.

Some people might feel more motivated if the percentage that vests each year increases exponentially rather than evenly.

While this approach isn’t that common yet, major companies like Amazon are shifting away from the traditional time-based vesting schedules to back-weighted vesting to retain employees for longer.

Reverse vesting

Reverse vesting is (unsurprisingly) the opposite of a traditional vesting schedule.

Instead of earning shares gradually, the shares are yours immediately. But to keep them, you have to stay with the company.

If you decide to leave, you may be required to sell back some or all of your shares to the company or other shareholders. Or your shares could be deferred (effectively worthless).

Reverse vesting is sometimes called ‘founder vesting’ because it’s mainly used by founders in very early-stage startups. But really, founders can design whatever vesting schedule suits them.

If you take the plunge and launch a business in the future, get a founder prenup to avoid any equity-related awkwardness.

Hybrid vesting

As you might expect, hybrid vesting is a combination of the types of vesting we’ve already covered. A mix of time and performance-based vesting - with a cliff - is common. There’s not really much more to say!

Immediate vesting

If your boss has already promised you options immediately, those options can immediately vest. So as soon as you accept the options or the grant date comes around, you’ll receive all of those options. 

And that's a wrap

The word vesting should now make a lot more sense! But let's quickly recap.

Vesting is a vital component of many share schemes, designed to reward your commitment and contributions over time.

Whether through gradual time-based vesting or performance-driven milestones, it’s important to understand how your vesting schedule works to get the most from your shares or options.

Check that your vesting schedule is clear, fair, and aligned with your long-term career goals. And if you're ever unsure, speak with your employer about the finer details and seek professional advice if needed.

And if your employer wants to make their life easier by digitising their company share scheme, tell them about us and our free, no-obligation consultations!

Frequently asked questions