Do I need a share vesting agreement?
By Will Elton, Last updated: 2022-03-24 (originally published on 2020-12-08)
A Share Vesting Agreement is a contract made between an employer and an employee (or consultant) that sets the terms and conditions for shares and share options to vest.
Employers will typically design share vesting agreements with proper incentives in mind to align the employee’s interest to that of the company. Essentially, while most common in startups, they are also used in many larger organizations to ensure that key executives can be attracted and retained.
Note that a Share Vesting Agreement is a different method of distributing shares than an Employee Share Option Plan (ESOP). Whilst both may make use of share vesting (more on that later), an ESOP allocates share options. For more information about share option plans, check out this in-depth article covering everything you need to know about ESOPs.
Why Are Share Vesting Agreements Used?
Share Vesting Agreements provide transparency for the company and for the employee. Typically used by startups and early-stage companies, they aim to protect the interests of both parties to ensure that share ownership is restricted and fairly earned (with clear guidelines). The performance of the employee is typically tied to ensure the success of the company, with the accompanying shares vested when specific performance criteria are met.
What Areas do Share Vesting Agreements Cover?
All terms of a Share Vesting Agreement must be transparent for both parties. Here are the areas you must cover in a well-drafted agreement:
- The shareholder’s name and contact details must be clearly stated along with the number and type of shares to be vested
- The agreement must clearly articulate the vesting criteria. Typically, there are two main criteria and many in-between:
- Time-based: where the shares vest based on a schedule; and
- Performance-based: where shares vest when certain employee key performance indicators (KPIs) are met.
- Cliffs can be specified. Cliffs are qualifying periods during which the employee will not qualify for any vesting. Typically from three months to a year, cliffs allow both parties to “try out” before any commitment of shares.
- Company buy-outs, acceleration, liquidity events. Any of these actions can cause the share options to vest more quickly, or even immediately. It is essential that these are specified in detail beforehand as these areas will likely cause disputes and disagreements.
What Are Acceleration Clauses?
Acceleration is an integral part of vesting agreements. Typically, acceleration clauses kick in when there is a “liquidity event”. Indeed, liquidity events are major corporate events that take place in a company’s life. For example, when a company floats on the stock market (IPO).
Clearly, in such a scenario a few things can happen. Undoubtedly, one common scenario is that the shares vest immediately. Alternatively, the shares may continue to vest over time but in a different manner. Obviously, the company must determine the appropriate course of action and customize the share vesting agreement as required.
What is Reverse Vesting
Ordinarily, a company creates a share vesting agreement for forward-looking incentivization. However, the real world doesn’t always conform to founders’ expectations. In essence, reverse vesting clauses give two considerable benefits to early stage employees and the company:
- Transfer shares to the earliest stage employee in the most tax efficient way; and
- Shares can be bought back by the company from shareholders who do not perform or who have started to behave in a way that is detrimental to the well-being of the company.
Companies should strive to protect themselves and their beneficial shareholders by building in this contingency for reverse vesting.
To sum up, share vesting agreements are essential documents that ensure transparency and clarity when awarding shares to employees from a company’s option pool or as a part of its long term incentive arrangements. Essentially, writing clear agreements and using easy-to-understand templates is key to ensuring that employers and employees operate in a fair and equitable manner.
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