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Concept of ESOP Vesting Period

Prabhat Nigam

| Updated: May 18, 2022 | Category: Annual Compliance

Concept of ESOP Vesting Period

A number of companies have been employing a technique in vogue these days of retaining their high value employees. This technique involves issuing company’s stocks to the employees in order to retain them for a considerable period of time and also to avoid taking debt from the market. A common practice followed by the companies issuing shares through ESOP scheme is the ‘ESOP vesting period’ where the employees get to access the options or shares of the company after the ESOP vesting period expires.

In ESOP schemes where vesting period exists, the employee does not get the benefit of the share in the ownership of the company until the vesting period expires. If an employee leaves the employment before the expiry of the ESOP vesting period, then such an employee cannot exercise the options issued under the ESOP scheme.  

This article covers various aspects of the ESOP vesting period right from the definition and need of ESOP vesting period till the alternatives of vesting period.  

What Is The ESOP Vesting Period?  

ESOP vesting period is that period that exists between the times when the employees are issued ESOPs till the time such employees gain access to the rights that attach to the options or shares. Only after the ESOP vesting[1] period expires do the employees get to access these shares.  

What Is the Need of ESOP Vesting Period?  

There is no legal mandate on the companies to have a vesting period. However, the companies deliberately keep a substantial vesting period for the following reasons:

To ensure loyalty of employees: Generally the ESOP vesting periods of similar companies are standard. The primary reason for having vesting period in the first place is to ensure loyalty of the employees with the company over medium to long period of time. If the employees get access to the options at the beginning of their employment with the company, then the chances of them remaining with the company for a long time become a little dim for lack of any further incentive.

To achieve commercial objective: In ESOP schemes where shares are issued, the company aims to achieve its commercial objectives through different means. For instance, if an employee who has been issued shares under ESOP scheme wishes to discontinue the employment, then the possible consequences of selling of their shares at discounted rates or even forfeiture may discourage the employees to leave their employment before maturity of their vesting period. This way, vesting period helps in achieving the commercial interests of the company without employing other means.

Tax treatment for ESOPs: The ESOP vesting period also has consequences on the tax treatment of the scheme. For instance if an employee’s interests are subject to a possible forfeiture upon gaining access to such shares, the vesting period comes to the rescue of the employee which allow him to defer the time when he would be required to pay tax on a discount he would get at the time he acquires the shares at the end of the vesting period.

Ideally, How Long Should The ESOP Vesting Period Be?  

There is no straight jacket formula for an ideal ESOP vesting period for a company. There is no ‘standard’ ESOP vesting period. It varies from as little as 12 months to 3 years and even beyond that. It depends on the following factors:

  1. Stage of growth of the company: Usually, growing start-ups offer a short term vesting period from 12 months to 18 months because of their uncertainty and the materialisation of such stocks in the future. Big companies especially blue chip companies offer long vesting periods  because of their sheer size and proven record and better negotiating power.
  2. Financial situation of the company: The financial status of the company also determines the vesting period. Early age start-ups wish to have longer vesting periods as they do not want attrition in the organisation especially in their formative years where the company is in the exponential growth stage. Big companies too wish to have longer vesting periods as the cost of employee integration is huge for every new employee.

The best practices that have been followed in the market is to have vesting period from 18 months to 24 months as this will help the company in exploiting the potential of the employee to the greatest extent possible.       

What Is The Difference ESOP Vesting Period And Restriction Period?  

The restriction period refers to a period during which am employee is restricted from selling his shares or options. Such a restriction begins after the shares have been vested in the employee whereas in case of vesting period, the shares have only been issued but not vested in the employee and the employee does not have any right to sell them because he does not own them completely.

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

Vesting period is essentially a waiting period or a minimum period of service which the employee needs to invest in the company compulsorily in order for vesting of shares to take place. However, a minimum employment period is not the only criteria for vesting of shares to take place. In some ESOP schemes, the employee gets the access to the shares or options upfront on the basis of meeting a specific performance criteria or achieving a set target.

Conclusion 

After discussing various facets of ESOP vesting period, it can be concluded that vesting period is put in place to achieve dual objectives for the company; the primary one being to incentivising the employees in the short term and the other one is to encourage the employees to remain associated with the company even after achieving their performance targets.

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

Prabhat Nigam

Prabhat has done his BA LLB (Hons) and has been writing research papers since his law school days. His interest in content writing made him pursue a career in legal research and content writing. His core areas of interest are indirect taxes, finance and real estate.

Business Plan Consultant


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