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Decoding Stock Option Vesting: Key Concepts Unveiled

Employee stock options are a way for employees to have a stake in their company’s success, but it’s crucial to understand the rules that govern them. The process starts with the company creating a plan approved by shareholders to issue stock options. Then, the Board decides which employees get these options. After that comes vesting.

Vesting is all about earning the right to buy shares, but it doesn’t happen all at once. Instead, it occurs over a period known as the vesting period. This period, usually spanning several years, allows employees to gradually gain ownership rights to shares or stock options provided by their employer.

How and when your options become available depends on your vesting schedule. This schedule might be based on time passing, the company’s performance, or a mix of both. Understanding your vesting schedule is crucial, and you can typically find this information in the grant letter given to you when you receive the options. Vesting schedules can be classified as time-based, performance-based, event-based, or a combination of these. 

Time-Based Vesting:​

Options are earned gradually over the employee’s tenure with the company. For example, if an employee is granted 1,152 options with a one-year cliff and a 4-year vesting period, 25% of the options vesting each year.

Number of options vested each year will be:

Year 1:  1,152(25%)= 288 options

Year 2: 1,152(50%)= 576 options

Year 3: 1,152(75%)= 864 options

Year 4:  1,152(100%)=1,152 options

Performance Based Vesting

Vesting happens by meeting specific goals, such as reaching sales or revenue targets. For example, suppose an employee has 1,500 options, and their vesting is contingent upon achieving a sales target of 1 crore in the first year and 3 crores in the second year. With 40% vesting permitted in the first year and 60% in the second year, the options will vest as follows:

Event: 1st Milestone- 1 crore
Percentage: 40%
Number of Options Vested: 600

Event: 2nd Milestone- 3 crores
Percentage: 60%
Number of Options Vested: 900

Event Based Vesting:​

Options vest upon the occurrence of significant company milestones, such as going public or achieving profitability. For example, an employee granted 100 stock options may vest once the company reaches a valuation of ₹50 crores. In this case options vest as follows:

Year 1: Valuation ₹10 crores, Options Vested: 0

Year 2: Valuation ₹25 crores, Options Vested: 0

Year 3: Valuation ₹48 crores, Options Vested: 0

Year 4: Valuation ₹60 crores, Options Vested: 100

Year 5: Valuation ₹82 crores, All options vested already, so no further vesting

Acceleration of Vesting:

Acceleration of vesting refers to situations where the vesting schedule for stock options is overridden, allowing option holders to become shareholders earlier than initially planned. There are two main types of acceleration: single trigger and double trigger.

Single Trigger:

This occurs when the vesting of stock options accelerates due to a single specified event or factor outlined in the plan. For example, if the company is acquired, the vesting of options may speed up immediately upon the completion of the acquisition, regardless of other conditions in the vesting schedule.

Double Trigger:

In contrast, double trigger acceleration happens when more than one event leads to the acceleration of vesting for an employee’s stock options. Typically, this involves a combination of events, such as termination of employees following the company’s acquisition or a change in ownership. T
hese events can result in stock options vesting earlier than originally planned in the vesting schedule.

Understanding both single and double trigger acceleration is crucial for both companies and employees, as it affects the timing of stock option vesting and can significantly impact individuals’ equity compensation in various corporate scenarios.

Impact Of Employee Status On Vesting Of Stock Options​

Voluntary Termination:
Upon voluntary termination, employees with vested options typically have a window to exercise them, ranging from months to years. Failure to do so within this timeframe may result in forfeiture of option rights. Unvested options are cancelled from the date of separation.   

Termination by the Company:
If termination occurs at the company’s discretion, the treatment of stock options varies. Vested options may remain exercisable for a set period post-termination, while unvested options may be forfeited and added back to the pool. 

In the event of an employee’s death, unvested options may automatically vest. Vested options usually follow the same exercise process. Employee’s beneficiaries or legal heirs have the right to exercise the options within a specified timeframe.

Further, as part of the termination process, the company can purchase all or part of the equity shares allotted to the employee pursuant to the exercise of options or otherwise direct the employee to transfer the equity shares to any person/entity nominated by the company at the minimum permissible price.

Customizing vesting plans to fit the company’s stage and employee preferences is important. Staggered vesting schedules recognize ongoing contributions and instill confidence. Understanding departure conditions and vesting terms for stock options is also crucial for employee experience and effective equity incentive programs.

By prioritizing clear communication and equitable treatment, companies can strengthen employee engagement and maximize the effectiveness of the stock options. 

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