Vested Shares Explained: Timing and Benefits for Employees

Retaining talented employees and rewarding loyal co-founders can be critical for your startup’s long-term success. One powerful tool is vesting schedules, a key component of many employee compensation packages. This article will explain vested shares and vesting schedules and their purpose in a startup business while highlighting legal insights.

What Are Vested Shares? 

Vested shares are shares or stock options that employees or co-founders own. Vesting means that rather than receiving shares outright when they first join your business, an individual’s shares become ‘vested’ over time, meaning they own the shares at a point in the future.

A vesting schedule determines when employees earn the right to own their shares. Vesting schedules are a common feature of employee stock option plans (ESOP), founders’ agreements, and other equity compensation schemes. You would usually spread this schedule out over several years. For example, you might set a definitive point at which shares are fully vested, such as four years in the future. You might also set certain performance conditions that your employees or co-founders must meet to earn their shares fully.

Vesting schedules usually come with a ‘cliff’. For example, a one-year cliff means an employee must stay with the company for at least one year before any shares vest. After this first year, a portion of the shares will vest, and the remaining shares will continue to vest over the remainder of the vesting period, usually monthly or annually. This ensures that the individual remains with the company for a certain period before fully benefiting from the vesting schedule.

A vesting schedule’s primary purpose is determining how an individual earns their shares or stock options. The schedule can incentivise employees and founders to stay with your company long-term, thereby enhancing employee retention. Vested shares also play a critical role in an employee’s potential exit strategy. The prospect of future financial gain can be a strong motivator, especially in the startup ecosystem.

Legal Considerations Associated with Vested Shares 

1. Drafting Clear and Enforceable Vesting Agreements 

You must clearly outline the vesting schedule and any additional vesting terms in the share agreements you share with those you grant shares or options subject to a vesting schedule. You must specify aspects such as:

• the schedule; 
• the conditions under which shares vest; and
• what will happen if the employee leaves your company or you sell the company before their shares or options are fully vested. 

The agreement must be clear and legally binding to avoid disputes in future. Working with an experienced lawyer to draft these agreements is best practice. A lawyer can help you to ensure that these critical contracts comply with the law and protect your startup’s interests. 

2. Tax Implications 

Shares and share options can have tax implications for employees and your company. Tax liability can depend on the difference between the shares’ market value when they vest and their price upon grant. It is a good idea to seek professional financial advice to clarify the tax implications of your share or equity compensation plan. An accountant can also help you to seek HMRC approval of the share’s market value at grant, if necessary.

3. Ownership Dilution 

Your stake will dilute as your company gives others portions of ownership through shares. It is crucial to manage this dilution carefully, and you should carefully consider how the vesting plan will impact your ownership over time. 

4. Accelerated Vesting 

Some vesting agreements include accelerated vesting clauses, where all or a portion of unvested shares vest immediately in certain circumstances, for example, if you sell your company. If you implement accelerated vesting clauses, ensure their conditions are fair and in your company’s best interests. 

Key Takeaways 

Vested shares are shares that an individual has fully acquired. Vesting schedules are a common feature of share and share option schemes. When an employee’s shares are fully vested, they have earned all their allocated shares. 

A vesting schedule sets out how employees will gradually earn shares or stock options, typically over several years. At the end of the vesting period, employees fully own their shares. Using a vesting schedule in your company’s employee share scheme can motivate employees to remain with your company long-term, enhancing employee retention.

In addition to employee share schemes, vesting schedules are a common feature of many founders’ agreements. Implementing a vesting schedule among co-founders can mean that if a co-founder leaves the company prematurely, they will not earn full rights to their shares. 

If you require legal advice about vested shares or setting up a share scheme for your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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