Vested Shares Is A Very Useful Practical Tool
Whether it’s through setting up your own company or an employment stock option, retirement or pension plan, vested shares is a very useful practical tool.
The use of vesting arrangements is very common in the US but less so here in the UK. In simple terms, shares are issued and then, in your capacity as an investor or employee, you can earn back the value of those shares or stock options by virtue of:
- Time : You may be required to hold the shares for X years before you’re entitled to them. The shares may be granted on a staggered basis over a period of time (known as graded vesting) or all at once (known as cliff vesting). Equally the vested shares may be vested on a uniform basis (ie 25% of the shares each year for 4 years) or on a non-uniform basis (ie 20%, 20% and 60% over years 1-3);
- Event : Your right to them arises on a certain event such as an IPO or a change of control of the company;
- Target : Personal or corporate performance target i.e. achieving a certain level of sales.
It’s a useful approach for investors and employers because it can provide motivational incentives on one hand but safeguard interests on the other.
The structure of vesting arrangements is slightly different for employment options but you get the general gist.
Using a business start-up example, Brendan and Tonia decide to start a company and agree to each own 50 shares with a vesting schedule. They agree that their share interests will be uniformly vested over a 4 year period with a provision that if either leaves the company within the first 12 months, he/she will forfeit the right to keep the vested shares and receive fair value for them.
This vesting mechanism protects the company and the founding shareholders. In the absence of forward planning, Tonia may have decided to leave the company after a couple of months and retained her shares.
50% of Tonia’s vested shares will have vested if she decides to leave after 2 years. In that instance, the vesting arrangements will determine whether she keeps the 25 vested shares or whether she is required to offer them for sale to the company or to Brendan (at fair value).
So vesting arrangements can make or break a company in its early stages. Money is tight and without the safeguards in year 1, Brendan may not have been able to buy Tonia out and the business would have effectively folded. Equally Brendan’s enthusiasm would also be tested to the limit knowing that he is putting all the hard work in and only achieving 50% of the benefits!
It is a complex area and as with this generic example, the decisions made from the outset of trading could have numerous legal ramifications in years to come…
If your business starts trading but is not yet incorporated, then it is a good idea to particularize your vesting arrangements in a collaboration agreement. The most important thing is to discuss the division of income, equity and control and put it in writing.
A shareholders’ agreement will set out the nature and extent of terms upon incorporation. – don’t skip this important document nor try to do on the cheap. A poorly drafted shareholders agreement could come back to haunt you in years to come.
Final Words: What It Means To Have Vested Shares
After reading this post, you’ll now have an idea about what it means to have vested shares and the different options available for them, and how they benefit you. If you have any legal questions about vested shares, if you already have vested shares and would like to know more then book a free Startup Legal Session below.