what are the two types of vesting?
toddauthorTwo Types of Vesting: Explained and Their Importance
Vesting is a crucial aspect of employee compensation and equity awards, such as stock options and restricted stock units (RSUs). It determines the timing and amount of shares that an employee receives after a certain period of service or achievement of a performance goal. There are two main types of vesting: linear and graded vesting. This article will explain the differences between these two types and their importance in the context of employee retention and stock price volatility.
1. Linear Vesting
Linear vesting is the most common type of vesting and means that a certain number of shares will become available for payment on a fixed date after a certain period of service has been completed. The shares become fully vested at the end of the vesting period, or they remain unvested if the employee leaves the company before the period is over. With linear vesting, the employee has a fixed amount of time to exercise their options or RSUs, after which they expire.
Benefits of Linear Vesting
- Simple and straightforward: It's easy to understand and manage, as there's a clear deadline for vesting.
- Employee retention: Employees have a clear incentive to stay with the company for the entire vesting period because they stand to benefit from the shares if they complete the period.
- Stock price volatility: The vesting period can help smooth out stock price fluctuations by ensuring that shares are released over time rather than all at once.
2. Graded Vesting
Graded vesting is a slightly more complex version of linear vesting in which the amount of shares vested over time increases or decreases based on certain factors, such as performance goals or length of service. Graded vesting can take various forms, including linear graded vesting, where the shares increase or decrease linearly over time, or more complex graded vesting models that take into account multiple factors.
Benefits of Graded Vesting
- Flexibility: Graded vesting offers more flexibility in structuring compensation plans, as it can be tailored to the specific needs of the company and employee.
- Employee engagement: By providing an incentive that increases or decreases over time, graded vesting can encourage employees to stay with the company for longer periods and be more engaged in the company's goals.
- Adaptability: Graded vesting can be more adaptable to changes in the market or company performance, as the amount of shares vested can be adjusted based on factors such as performance goals or length of service.
Both linear and graded vesting have their advantages and disadvantages, and the best option will depend on the specific needs of the company and employee. Linear vesting is the most common and simple to understand, while graded vesting offers more flexibility and engagement. Companies should consider the benefits and drawbacks of both types when structuring their equity compensation plans to best incentivize and retain their employees.