Concept of ESOP Vesting Period

Minakshi Bindhani

30 Aug, 2023

Introduction

Many businesses have been using a popular strategy these days to keep their valuable staff. This strategy involves giving employees company stock in order to keep them around for a long time and prevent borrowing money from the market. The ‘ESOP vesting period’, which allows employees to access the Company’s options or shares after it has expired, is a typical practice adopted by businesses that issue shares under ESOP schemes¹.

In ESOP plans with vesting periods, the employee does not profit from the share in firm ownership until the period has passed. An employee cannot use the options granted under the ESOP plan if they quit their job before the ESOP vesting period has passed.

The numerous facets of the ESOP vesting period are covered in this article, from its definition and necessity through its various options.

What Is The ESOP Vesting Period?

The ESOP vesting period is the time frame between when employees get their ESOPs and when they are able to exercise any attached rights to options or shares. The employees are only able to obtain these shares once the ESOP vesting term has passed.

What Is The Need Of ESOP Vesting Period?

The companies are not required by law to have a vesting period. But for the following reasons, the firms purposefully maintain a vesting period:

• To guarantee staff loyalty: The ESOP vesting schedules of comparable companies are typically uniform. To ensure employee loyalty to the organization over a medium to lengthy period of time, the vesting period’s primary purpose in the first place. If employees are given access to alternatives from the start of their employment with the Company, their chances of staying with the business for a long time decrease due to the lack of additional incentives.
• Commercial goal: In ESOP schemes where shares are issued, the corporation seeks to accomplish its commercial goals via a variety of techniques. For instance, if an employee who has been granted shares under the ESOP scheme wishes to end their employment, the potential repercussions of selling their shares at a loss or even forfeiture may deter them from doing so before the end of their vesting period. In this manner, the vesting period aids in attaining the business objectives of the Company without the use of additional methods.
• Tax treatment for ESOPs: The tax treatment of the plan is impacted by the ESOP vesting period. For instance, the vesting period protects the employee by allowing him to postpone the time when he would have to pay tax on a discount he would receive at the time he acquires the shares at the end of the vesting period if his interests were subject to a potential forfeiture upon gaining access to such shares.

How Long Should The ESOP Vesting Period Be?

For a company’s ideal ESOP vesting term, there is no hard and fast rule. No standard ESOP vesting period exists. It can range anywhere from 12 months to 3 years and even longer. According to the following elements:

• Stage of a company’s growth: Growing start-ups typically offer a short vesting time of 12 to 18 months due to their uncertainty and the potential future materialization of such equities. Due to their sheer size, established track record, and superior negotiation strength, large corporations, particularly blue chip companies, give lengthy vesting periods.
• Financial standing of the Company: The vesting period is also based on the Company’s financial standing. Early-stage start-ups want vesting periods to be longer because they don’t want attrition, particularly during the Company’s formative years when it is in the exponential growth stage. Due to the high cost of employee integration for each new hire, big organizations also want longer vesting periods.
• The vesting term should be between 18 and 24 months, as this will allow the Company to fully utilize the employee’s potential. This is the best practice that has been adopted in the market.

What Is The Difference Between the ESOP Vesting Period And the Restriction Period?

A period of time during which an employee is prohibited from selling his shares or options is referred to as the restriction period. Such a restriction only applies once the employee has fully vested in the shares; during the vesting period, the employee has only received the shares and has no legal right to sell them because he does not yet fully own them.

Are There Any Other Criteria For the Vesting Of Shares Apart From the ESOP Vesting Period?

The vesting time is simply a waiting period or a minimum term of service that the employee must compelfully participate in the business before their shares vest. A minimum employment duration is not the only need for share vesting, though. In some ESOP plans, the employee receives immediate access to the shares or options in exchange for meeting certain performance standards or a predetermined goal.

Conclusion

An important component of employee stock ownership plans (ESOPs) is the vesting period, which specifies how long an employee must be employed by a company before becoming the sole owner of stock options or grants received from the employer. The employee often gains access to a particular percentage of the options or shares over the course of this period, which is typically broken down into incremental stages. The vesting period promotes employee engagement and loyalty by incentivizing them to remain with the Company for the allotted time in order to get the full value of their stock holdings. Employees can exercise their stock options or claim the given shares after the vesting period is finished, connecting their financial interests with the Company’s success and encouraging a sense of ownership.

Frequently Asked Questions

Read Our Article: Employee Stock Option Plans (ESOPs)- An Overview

1. https://www.sebi.gov.in/sebi_data/attachdocs/1289549364138.pdf