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Definition of Share Vesting

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Explanation

Vesting of shares implies that the counterparty will get entitled to shareholding rights of shares over a period of time by providing agreed services to the company. Share vesting means rewarding shares to the founders, employees, and owners as a part of compensation or retirement benefits. It is also a way to award and retain the employee. This process is usually a long-term process and maybe range from four to five years. Share vesting helps a corporate body to ensure employee loyalty towards the company. Share vesting terms and conditions may be defined under the shareholder’s agreement in the case of the founder of the company, whereas, in the case of employees, vesting terms are defined in the employee contract/ policies. If an employee quits the organization and has vested shares, then the organization may have the option to repurchase the shares at the original issue price, that is, par value.

Example of Share Vesting

Following are the examples are given below:

Example #1

Many employees have been working in a company for more than 20 years, and now the company has decided to reward them for their loyalty to the company. In such a situation, the company can offer them its shares with a share vesting plan. Accordingly, a vesting plan of four years was created to offer 1000 shares of the company to such employees. Such shares will be vested completely after a period of four years, and a cliff of one year was also added. There was one more ruler added, known as after cliff, which states that the next percentage of shares which will be awarded after the first part has been issued. Similarly, the remaining shares will be awarded the same until the vesting period ends.

The employee will get 25 percent of the total shares at the end of year one, with a vesting period of four years and one year of cliff time. The company can set the rule that the employee cannot sell the shares until the vesting period is over. This will help the company secure its assets i.e. the employee, by rewarding him and making him stay longer. If the employee leaves before all the shares are vested, the company has a right to take back all the shares in the company’s account.

This can be understood better by the following chart-

Time

Percentage of Vested Shares

Start of The Vesting 0

At the End of Year One 25

At the End of Year Two 50

At the End of Year Three 75

At the End of Year Four 100

Example #2

Date

Option Vested

01 January 2023 60

01 February 2023 5

01 March 2023 5

01 April 2023 5

01 May 2023 5

01 June 2023 5

So On, till the completion of the entire vesting period.

Share Vesting Tax Treatment

Share vesting is taxed differently than any other stock option, like an employee stock purchase plan; these plans are generally taxed at the time of the exercise of sale. Still, the vesting shares become taxable on completion of the vesting period. for vesting, the complete amount of vested stock forms part of the total income in the year of vesting.

If a person elects section 83(b), he is allowed to report the fair market value of the shares as ordinary income as on the date when they are granted in place of the date when they become vested. The stockholder will still be liable for capital gain rules but from the grant date. The selection of this section can lower the taxes that need to be paid as the stock price is much lower at the time of grant than when it is vested. this section is very helpful in cases where there exists a long interval gap between the grant of shares and their time of being vested.

Share Option vs Share Vesting

Share vesting and share option are both forms of equity compensation but have different conditions and characteristics. Vested shares are rewards and compensations completely to the founders and employees for their loyalty towards the business and have the same rights and privileges as of a shareholder i.e. They will receive dividends and can vote in the annual meetings. but the company has all rights to take back unvested shares if the employee leaves the job before the vesting period ends. While stock options are the right o buy a certain number of shares at a fixed price on a future date. It benefits the owner only if the stock market price increases and exceeds the option purchase price.

Advantages

It does not involve any cash outflow, forming an important reward for both parties. no money flows out from the books of the company. It is only a company offering ownership to its employees.

It is very helpful for startups as initially they cannot provide high salaries but can give vesting of shares as compensation to attract the employee.

Employees perform the vesting of shares on a long-term basis. the actual vesting benefit will occur only to employees retained during the entire vesting period.

If an employee leaves the job or is terminated from the job, he may not avail full benefits of vesting.

Conclusion

It can be defined as an agreement between a company and its investors, co-founders, and employees to grant its shares after the fulfillment of a certain time period or on the fulfillment of agreed terms and conditions. This vesting helps to ensure long-term relations between agreed parties and tends to increase loyalty towards the company. even it benefits the company as it does not involve cash outflow. Employees are taxed for such rewards and, therefore, may sometimes find it less attractive if in case a non-taxable reward is also available.