Share Vesting

Definition of Share Vesting

 Share vesting can be defined as an agreement entered by a body corporate and its investors, shareholders, employees or co-founders whereby agreed party is provided company’s stock after a pre-decided period of time or after the fulfilment of agreed terms as a  part of the compensation or maybe a contribution to the pension scheme for its employees or co-founders of the company in order to reward them for their performance and/ or to retain for longer period of time.

Explanation

Vesting of shares implies thatcounter party will get entitled to shareholding rights of shares over a period of time by providing agreed services to the company. Share vesting simply means rewarding of shares to the founders, employees and owners as a part of compensation or retirement benefits and is also a way to award and retain the employee. This process is usually a long-term process and maybe ranging for four to five years. Share vesting helps a body corporate to ensures an employee loyalty towards the company. Share vesting terms and conditions may be defined under shareholders agreement in case of the founder of the company whereas in case of employees, vesting terms are defined in the employee contract/ policies. In case if an employee quits organization and has vested shares, then organisation may have an 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 employeeshave been working in a company for more than 20 years and now the company decides to reward them for their loyalty towards the company. In such a situation the company can offer themits 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, remaining shares will be awarded the same till the vesting period is over.

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

This can be understood better by following chart-

Example #2

Amazon Inc. hired sam on 01 january 2019. his salary package includes a vesting plan for four years for 240 shares of amazon inc. the plan was granted on 01 january 2019 with monthly 5 shares with one-year cliff. Here the cliff year will end on 01 january 2020 and sam will be given 60 shares (25% of total shares i.e. 240 shares) he can exercise his rights over these 60 shares.

So On, till the completion of entire vesting period.

Share Vesting Tax Treatment

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

The amount that needs to be declared as income is determined by deducting the exercise price or the purchase price of the stock from a fair market value of a stock as on the date when the stock is fully vested. The difference between the two must be reported as ordinary income by the shareholder. But in case if the stock is not sold by the shareholder at vesting and is sold at a later time, then the difference between the sale price and fair market value on the date of vesting must be recorded as a capital gain.

If a person elects section 83(b) then 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 holder of stock will still be liable for capital gain rules but from the date of grant. The selection of this section can lower the taxes that need to be paid as the price of the stock is much lower at the time of grant than at the time of it being vested. this section is very helpful in case where there exist 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 both are forms of equity compensation but both have different conditions and characteristics. Vested shares are rewards and compensations completely, to the founders, employes for their loyalty towards 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 is beneficial fo the owner only if the stock market price increases and is more than the option purchase price.

Advantages

Some of the advantages are given below:

• It does not involves any cash outflow and therefore forms 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 advantageous for the employees also as the company grants them with a position of receiving high-value shares.
• Employee contract including a share vesting clause leads to the improvement of the overall performance of the employee.
• Share vesting leads to employee retention. when there is a potential gain or reward in the future in the form of shares vested the employee will work hard and will stay in the company for longer periods without quitting the job.
• It is very helpful for startups as initially the are not able to provide high salaries but can give vesting of shares as compensation to attract the employee.

Disadvantages

Some of the disadvantages are given below:

• Vesting of shares is performed by employees on a long term basis. the actual benefit of vesting will occur only to employees who are retained during entire vesting period.
• Tax is the most disadvantageous factor for vesting of shares. tax liability will vary in different types of shares that are vested. taxes will be levied on choosing the date of purchase and sell of stock option. rewards earned in the form of shares vested will incur income tax liability.
• 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 in between a company and its investors, co-founders, employees to grant its shares after the fulfilment of a certain time period or on the fulfilment of agreed terms and conditions. This vesting helps to ensure long-term relation in between agreed parties and tends to increase loyalty towards the company. even it is beneficial for 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.

Recommended Articles

This is a guide to Share Vesting. Here we also discuss the definition and examples of share vesting along with advantages and disadvantages. You may also have a look at the following articles to learn more –

1. Ordinary Shares
2. Shareholders Agreement
3. Earnings Per Share
4. Issued Shares vs Outstanding Shares