Vesting of award: Overview, definition, and example
What is vesting of an award?
Vesting of an award refers to the process by which an individual gains full ownership or entitlement to a specific benefit, right, or asset after meeting certain conditions or requirements set forth in an agreement or plan. Typically, the term "vesting" is used in the context of employee compensation, such as stock options, retirement benefits, or incentive awards. Once an award vests, the individual has the legal right to claim or exercise the award, which could be the right to access retirement funds, exercise stock options, or receive a bonus payment.
Vesting is often subject to specific conditions, such as a length of service (e.g., the employee must remain with the company for a certain number of years) or meeting performance goals. The purpose of vesting is to encourage long-term commitment or achievement and align the interests of the individual with the goals of the organization or plan.
Why is vesting of an award important?
Vesting is important because it establishes the conditions under which individuals can fully access or benefit from a given award. For employers, vesting serves as a tool to retain employees by incentivizing them to stay with the company or reach certain performance milestones. For employees or recipients, vesting provides clarity on when they will receive full entitlement to the award, helping them plan their financial and career decisions.
Vesting also helps ensure that the employer is not forced to pay out benefits to employees who have not met the conditions, such as staying with the company for a specified period or achieving agreed-upon performance goals.
Understanding vesting of an award through an example
Let’s consider an employee who is granted 1,000 stock options as part of their compensation package. These stock options are subject to a 4-year vesting period, with 25% of the options vesting each year.
- In the first year, 25% of the options (250 stock options) become vested, meaning the employee can exercise those options (buy stock at a set price).
- In the second year, another 25% (250 options) vest, and the employee gains the right to exercise them as well.
- After 4 years, if the employee remains with the company, all 1,000 options will be vested, and they will have the right to purchase shares at the predetermined price, regardless of the current market value.
If the employee leaves the company before the 4-year period is complete, they may forfeit any unvested options.
In another example, an employee might be awarded a cash bonus contingent on meeting certain performance targets. The employee will not receive the bonus until the targets are met and the vesting conditions are fulfilled.
An example of a vesting of award clause
Here’s how a vesting of award clause might appear in a stock option agreement:
"The Stock Options granted to the Employee under this Agreement shall vest in four equal annual installments, with 25% of the total number of options vesting each year on the anniversary of the grant date, provided the Employee remains employed by the Company. If the Employee's employment is terminated prior to the vesting date, any unvested options shall be forfeited."
Conclusion
Vesting of an award is a critical concept in employee compensation plans and other agreements that involve deferred benefits or rights. It sets out the conditions under which an individual becomes fully entitled to the benefits or awards granted to them, such as stock options, retirement funds, or performance-based bonuses. Vesting encourages employees to stay with the company or meet specific performance goals, benefiting both the employee and the organization. By understanding the vesting process, both employers and recipients can manage expectations and plan for future benefits.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.