What Is Meant By Vested?
Being vested means you have earned the right to a present or future asset or benefit. Vesting typically refers to the process of earning ownership or control over an asset or benefit.
Example: If you joined a startup and received incentive stock options and your options are vested , this means you have achieved what was required of you to earn those stock option shares. This typically means you have stayed for a certain amount of time at the startup or have completed certain milestones.
Here is an article that dives deeper into vesting.
Vesting Defined
Vesting’s legal meaning is to earn the right to a present or future asset. Vesting is commonly found in employee stock options, restricted stock units, qualified retirement accounts, and pension plans. A stock option allows an investor to purchase stock at a certain price. A qualified retirement plan is an employer-sponsored retirement account that receives tax-deferred treatment under the IRS. A pension plan is a benefit where the employer makes regular payments to an employee’s retirement account. Vesting is also commonly used in real estate transactions and inheritance.
Vesting Schedule
A vesting schedule is a term that is included as part of the employee compensation package. A vesting schedule can apply to stock options, restricted stock, and qualified retirement plans. The vesting schedule outlines the requirements the employee will need to achieve in order to become vested, such as a certain number of years or the achievement of a specific performance milestone.
Here is an article on vesting stock.
What Are Vested Options?
Vested options are employee stock options that have been earned and now belong to the employee. Before they were vested, they were not owned by the employee. In other words, the employee has achieved what was required in order to earn the options, which is typically tied to time.
Example: If John joined a company that issued him 500 restricted stock units with a vesting schedule of one year. John’s shares will be vested once he stays for one year.
For options, this means the employee now has the right to exercise the options they have earned that have vested. To exercise stock options means you buy the shares at a pre-determined price with the idea they will be worth more than the purchase price.
Here is an article on incentive stock options.
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What Is A Vested 401k?
Being vested in relation to your 401k funds refers to the amount of money you can take with you when you leave your company. You will always be able to take the money you have personally contributed to your 401k when you leave, but this may be a bit different as it relates to money contributed by your employer through some sort of employer matching scheme.
Many employers will set vesting schedules regarding their contribution to your 401k, which are typically time-based vesting schedules. Make sure you read your employment offer to better understand this.
Example: An employer may offer a 401k program to employees where the employer matches your contribution dollar for dollar. In other words, if you contribute $500 per month to your 401k, your employer will match the $500 contribution as well. However, the employer may set up a vesting schedule on their matched contribution, which could be three to seven years.
Here is an article about 401k vesting.
What Does It Mean When You Are Fully Vested?
Being ‘fully vested’ or ‘100% vested’ means you have accomplished all achievements required to be entitled to the asset, payment, or benefit that was previously vesting. Simply put, you have fully earned your right to the asset, payment, or benefit. For example, a retirement plan may vest immediately, after three years of service, or another set time period.
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Examples of Being Vested
Understanding what being vested means can be complicated, so we want to run you through a few examples of what it means. There are many more examples beyond what is below, but this example should give you a good idea of what it is meant when someone says vested.
Vested Options
Stock options give an employee the ability to earn the right to buy shares of their employer at a pre-determined price in the future. The pre-determined price is a reflection of the fair market value of the stock at the time of the grant, which in theory should appreciate by the time the employee purchases the shares netting the employee a profit.
Here is an example:
- You join an early-stage startup and are issued 40,000 shares of stock options.
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Your vesting schedule includes:
- Four-year timeframe
- One-year cliff
- 25% of shares vest each year
- After one year, the stock vests monthly, equally
- After one year of employment, 10,000 shares are vested (25% of total grant).
- After two years of employment, 20,000 shares have vested (10,000 vested in year two).
- After three years of employment, 30,000 shares have vested.
- After four years of employment, 40,000 shares have vested and you are 100% vested.
- If the employee chose to leave after two years of service, the employee will have earned 20,000 shares and would leave without the other 20,000 shares vesting.
One thing to keep in mind with stock options are the employee does not own the shares once vested. They simply have earned the right to exercise the shares in the future. Meaning, if the share price is higher than the exercise price at some sort of liquidity event, the employee can buy the shares at the lower price to make a profit.
Here is an article that digs deeper into how vested options work.
Vested Equity
Vested equity or vested stock means an employee has earned the right to shares of the company by accomplishing some sort of achievement laid out by the vesting schedule. One form of vested equity or vested stock is restricted stock units or RSUs. RSUs, unlike stock options, are owned outright by the employee after they have vested.
Here is an example of how this works:
- You join a startup as an executive and are offered 800 RSUs are part of your compensation package.
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The vesting schedule for your RSUs is:
- Four-year vesting schedule.
- One-year cliff.
- Shares vest 25% each year.
- After one year, shares vest quarterly.
- If you stay for one year, 200 RSUs would have vested.
- If you stay for two years, 400 RSUs would have vested.
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If you leave after 26 months, only 400 RSUs would have vested.
- This is because your RSUs are vested quarterly and you did not stay the entire first quarter of year three.
The example above is different since the employee would have equity ownership immediately after the RSUs vest. This is different than stock options since there is no exercising of RSUs.
Here is an article that digs deeper into employee equity.
Get Help Understanding Vesting
Being vested is a great thing but also difficult to understand all options. If you would like to consult a lawyer to get help, you can post a project in the ContractsCounsel’s marketplace. The lawyers would be happy to review any sort of employee stock purchase plan or employment agreement and advise on your options.
