Vesting is the process of receiving the full rights to shares over time or when business goals are achieved.
Vested shares form part of the compensation package of many skilled employees who work in UK tech startup, and they are becoming more popular in other industries.
The idea is that they attract and reward top talent at a time when the business might not be able to afford to pay market salaries.
This article looks at how they work, the advantages to an employer of giving them, and the things employees should consider when assessing their value.
What are vested shares?
Vested shares are shares (units of ownership) in a company for which you work, that were promised to you, as part of your employee compensation package, on the condition that certain milestones were passed.
By contrast, unvested shares are shares that have been promised, but that you are not yet entitled to.
Vesting periods and schedules
Shares typically vest on two bases - time-based and milestone-based. Time-based vesting gives you a certain number of shares at set intervals in the future, while milestone-based vesting rewards specific achievements.
If your shares are vested based on time, the vesting period is the interval at which share ownership is transferred to you.
A vesting schedule sets out when you receive shares, the conditions on which you receive them and the number you receive at any particular date.
Time-based vesting schedules
Time-based vesting schedules determine when you gain ownership of your shares over a set period.
A common vesting schedule is one that spans four years with a one-year 'cliff'. This means you don't receive any shares until you've worked at the company for a full year. After that, you gain ownership of a portion of your shares each month, quarter or year.
For example: you've been granted 4,800 shares over four years. After the first year, you'd receive 1,200 shares (25% of the total). Then, you might be given 100 shares each month for the next three years.
'Fully vested' shares are those you own outright once the vesting period ends. In a four-year vesting schedule, you'd be fully vested after working at the company for four years.
Milestone-based vesting schedules
Milestone-based vesting ties share ownership to specific performance targets. Those might be business targets or team targets. This method can motivate you to achieve key business objectives, or protect other shareholders against certain things not happening.
This approach aligns employee and company goals by rewarding achievements rather than mere time served - predetermined performance milestones such as product launches, revenue targets, or funding rounds.
For example, you might be granted 4,800 shares vesting over four years. With milestone-based vesting, you might receive 1,200 shares when the company secures its Series A funding, another 1,200 when monthly active users reach 100,000, and the remaining 2,400 when the company achieves profit over £20,000 a month.
What is a vesting cliff?
A vesting cliff is a set period, typically one year, before you receive any shares. 'Cliff vesting' ensures commitment and supports employee retention.
During the period until the date of the cliff, the right to receive the shares accrues to you. But ownership only passes when the date of the cliff passes.
Acceleration clauses and their impact on vesting
Acceleration clauses are provisions in equity management agreements that can speed up the vesting process under specific circumstances.
These are main types: single-trigger and double-trigger.
Single-trigger clauses kick in when there's a change in control of the business. For example, an investor buys in.
Double-trigger clauses require two events to occur: a change in control plus termination of your employment. These often happen when a co-founder leaves the company.
Stock options vs RSUs
Stock options and Restricted Stock Units (RSUs) are two common forms of equity compensation. Stock options give you the right to buy shares at a set price, while RSUs are outright grants of shares. The key differences lie in their vesting, taxation, and potential value.
Stock options require purchase at a strike price, which is the predetermined amount you pay to buy shares.
The strike price could be low, such as a pound, or it could be a much higher, such as the value that other shareholders paid at the funding round.
RSUs, on the other hand, are granted without any purchase requirement.
The tax implications differ too.
RSUs are taxed when they vest, meaning you owe tax on their value as soon as you receive them.
Options, however, are taxed when you exercise them - that is, when you actually buy the shares.
Tax implications of vested shares
The type of equity and vesting schedule affect how HMRC treats your shares.
Income tax considerations
You'll have an income tax liability when your shares vest, or when you exercise options.
The average income tax rate for UK employees with vested shares hovers around 40%. So if you receive £10,000 worth of vested shares, you're likely to owe £4,000 in tax, which needs to be paid regardless of whether you can sell your shares (usually you won't be able to quite yet).
Capital gains tax
Capital gains tax (CGT) applies to the profit you make when you sell vested shares.
The tax rate currently stands at 20% for higher rate taxpayers on gains above the annual exemption.
You'll pay CGT on the difference between the sale price and the price at which you acquired the shares.
Risks associated with vested shares
Vested shares in startups carry several risks. Half of all startups fail within five years, which puts your employee ownership at risk; the value of your shares can fluctuate wildly; and you might face unexpected tax bills when your shares vest or when you sell them.
Market volatility and startup valuations
Startup valuations fluctuate frequently, affecting the value of vested shares.
Tech startup valuations, for instance, vary by an average of 30% year-over-year. Economic downturns, industry disruptions, or poor company performance can slash share value significantly.
Illiquidity of private company shares
Private company shares lack liquidity. This means you can't easily convert your vested shares into cash.
Unlike publicly traded stocks, private company shares don't have a readily available market for buying and selling. The average time to a liquidity event (IPO or acquisition) for UK tech startups is 7-10 years. So expect to own your shares for a long time.
Vested shares as part of total compensation
On average, companies offer 0.1 to 2% equity each to early employees, balancing lower base salaries and benefits with potentially valuable vested shares and options.
Potential rewards
As an early employee with vested shares, you could see significant financial gains if your company succeeds.
Some UK tech startup employees have watched their equity value climb 10 to 100 times.
Impact of vested shares on career decisions
Being offered shares in your employer company will shape your career trajectory.
You might join a company for its equity compensation package or stay longer to fully vest your shares.
The 'golden handcuffs' effect is real: 60% of employees with vested shares report feeling more committed to their company.
Equity ownership affects employees psychologically. Research shows 75% of employees with equity feel more engaged at work. This heightened engagement stems from a sense of 'psychological ownership' - a feeling of personal investment in the company's success.
Legal rights of minority shareholders
By law, minority shareholders in a UK company do have several fundamental legal rights. These can protect your interests and ensure you have a voice in company matters. You can vote at general meetings, access company information, and call general meetings.
But you only have these default right if you hold at least 5% of the total ordinary shares, and they don't give you much control over what happens. In reality, small partial ownership means very little.
And if different share classes are used, your rights might be even more limited.
The importance of shareholder agreements
Shareholder agreements define the rights and obligations of shareholders. They contain key provisions that affect your ability to buy, sell, or transfer shares. They set out drag-along rights, tag-along rights, and pre-emption rights.
Exit strategies
Exit strategies are the options you have to cash in on your equity.
Initial Public Offering (IPO): The company lists its shares on a stock exchange, allowing you to sell your shares to the public.
Acquisition: Another company buys your employer, often offering cash or shares in exchange for your vested equity.
Secondary market sales: You sell your shares to private investors before the company goes public.
Share buyback: The company repurchases your shares, giving you a direct way to cash out.
Due diligence before accepting shares
Before accepting an offer with vested shares (if you do so because you think it might be valuable), you need to know the company's current valuation, how many total shares are outstanding and the vesting schedule.
For options you need to know the exercise price and whether there are restrictions on share sales.
You should also have a reasonable idea of the intended exit strategy to know when you'll get your money back.
UK regulations governing employee share schemes
The UK has a robust regulatory framework for employee share schemes. They include Enterprise Management Incentives (EMI), Company Share Option Plans (CSOP), and Share Incentive Plans (SIP).
HMRC-approved schemes offer tax advantages to both employers and employees.
Insider trading regulations in the UK apply to employees with vested shares, particularly during key company events or announcements.
These rules restrict trading when you possess 'inside information' - non-public, price-sensitive details about the company. The Financial Conduct Authority (FCA) enforces these regulations strictly.
Frequently asked questions
What happens to my vested shares if I leave the company?
When you leave your employer, your vested shares should remain yours.
You'll usually have an exercise window - a set period to buy your vested options - which can range from 30 to 90 days after your departure. Some companies offer extended windows of several years. However, the price at which you can sell them might be low.
Can I sell my vested shares at any time?
You can't always sell your vested shares immediately. Public and private companies have different rules for share liquidity. Public companies allow easier selling, but private firms often restrict share transfers. Your ability to sell depends on your company's policies and any agreements you've signed.
How can I estimate the value of my vested shares?
Estimating the value of vested shares in private companies presents unique challenges. Unlike publicly traded stocks, private company shares lack a readily available market price.
You'll need to rely on alternative methods to gauge their worth, such as discounted cash flow analysis, comparable company analysis, or recent funding rounds.