What Is a Vesting Period?
A vesting period determines how long an employee must be employed to earn benefits like stock options or 401(k) matching.
The vesting period ensures that employees show their commitment to the company for a certain period before receiving these benefits.
This is important to companies because it allows them to attract and retain loyal employees.
How Do Vesting Periods Work?
Vesting periods typically last for a few years, and employees must stay with the company to be eligible for the benefits.
If an employee leaves a company before becoming vested, that employee forfeits the employer's contributions to the account.
For example, if an employee receives stock options with a four-year vesting period, they cannot exercise those options until they have been with the company for four years. If the employee leaves before the four-year term, they will still be able to take any contributions they made but will not be able to keep the employer's match or contributions.
In other cases, vesting periods may be shorter or longer, depending on the type of benefit on offer.
Vesting periods are also common in retirement plans, such as 401(k)s.
Employees may be required to vest for several years to receive the employer match.
Types of Vesting Periods
Here are the different types of vesting periods:
- Cliff vesting: The most common vesting period requires employees to stay with the company for a certain period before they become fully vested.
For example, an employee granted stock options with a four-year cliff vesting period will not become fully vested until they have been with the company for four years.
- Graded vesting: This type of vesting period allows employees to vest gradually. This means they will vest a certain percentage after a set period and then vest another figure at each subsequent milestone.
For example, an employee granted stock options with a four-year graded vesting period may vest 20% after two years, an additional 30% after three years, and the last 60% after four years.
- Milestone-based vesting: This vesting period is based on achieving certain milestones, such as hitting sales targets or launching a new product.
For example, an employee granted stock options with a milestone-based vesting period may vest after the company hits certain financial goals.
- Immediate vesting: This type of vesting period allows employees to be immediately vested, which means they do not have to wait a certain period to receive the benefit.
For example, an employee granted stock options with an immediate vesting period can exercise those options as soon as they are granted.
Advantages and Disadvantages for Employers
There are advantages and disadvantages for employers when offering vesting periods.
Advantages:
- Vesting periods can help attract and retain employees
- They can motivate employees to stay with the company and hit certain milestones
- It is a good substitute for cash bonuses or raise
- Does not replace the need for short-term financial needs
- Designing the correct vesting schedule requires time, effort, and thought to ensure it is the best fit for the employer and employee
- Harsh vesting terms may cause employees to leave the company before they are fully vested
Other Vesting Considerations
Here are a few other things to consider when it comes to vesting periods:
- Vesting periods can vary depending on the type of benefit on offer
- Vesting periods may be negotiable during the job negotiation process
- Vesting periods can be a little complex to understand for some employees, so make sure to explain the details thoroughly
- Some benefits, such as 401(k) matching, may have mandatory vesting periods
Vesting for Start-Ups
Vesting periods are also common in start-ups. This is because start-ups often offer equity to employees as a way to attract and retain talent.
Vesting periods for start-ups typically last four years, with a one-year cliff vesting period. This means that employees will vest 25% of their shares after the first year and then vest an additional 25% at each subsequent milestone.
The Bottom Line
Vesting periods are the set amount of time employees must work for a company before they become fully vested in a benefit.
Employers may offer vesting periods as a way to attract and retain employees. They can also motivate employees to stay with the company and hit certain milestones.
FAQs
1. What if I leave the company before I'm fully vested?
You will not receive the full benefit if you leave the company before you're fully vested.
For example, if you have a 401(k) with a three-year vesting period and leave after two years, you can only keep the money you contributed plus any employer-matched contributions.
You will not be able to keep the money that would have been vested at the three-year mark.
2. What are the advantages of vesting periods?
Vesting periods can help attract and retain employees, serving as an incentive and a motivation to hit certain milestones.
3. What are the disadvantages of vesting periods?
Vesting periods, while satisfying long-term needs, do not meet the short-term needs of an employee. Designing and executing the correct balance with a vesting period can also be challenging. If the schedule is too harsh, it will fail to motivate employees to stay with the company.
4. Is a vesting period a good option for a start-up?
Vesting periods are a good option for start-ups because it attracts new employees with the promise of equity.
