Background: vesting rights and schedules

In law, vesting is the point in time when the rights and interests arising from legal ownership of a property are acquired by some person. Vesting creates an immediately secured right of present or future deployment. One has a vested right to an asset that cannot be taken away by any third party, even though one may not yet possess the asset. When the right, interest, or title to the present or future possession of a legal estate can be transferred to any other party, it is termed a vested interest.

The concept can arise in any number of contexts, but the most common are inheritance law and retirement plan law. In real estate, to vest is to create an entitlement to a privilege or a right. For example, one may cross someone else's property regularly and unrestrictedly for several years, and one's right to an easement becomes vested. The original owner still retains the possession, but can no longer prevent the other party from crossing.

Inheritance

Some bequests do not vest immediately upon death of the testator. For example, many wills specify that an heir who dies within a set period (such as 60 days) is not to inherit, and further specify how the corresponding share is to be distributed. This is generally done to obviate disputes over the precise time of death, and to avoid paying taxes twice in rapid succession should multiple members of a family die in the wake of a disaster. Such a bequest does not vest until the expiration of the specified period, because the actual heir cannot be determined with certainty.

It is also possible to give a person, A, a life interest in a property, with the remainder to go to another person or persons, B. If the beneficiary of the remainder cannot yet be known, then the remainder is said not to have vested, and the remainder is said to be contingent. This may happen with entailed estates, or when property is left in trust to care for a child or relative without heirs. (See trust law for details).

Retirement plans

Vesting is an issue in conjunction with employer contributions to an employee stock option plan, deferred compensation plan, or to a retirement plan such as a 401(k), annuity or pension plan.

Once a retirement plan is fully vested, the employee has an absolute right to the entire amount of money in the account. It is a "basic right that has been granted, or has accrued, and cannot be taken away"; for example. one has a right to a vested pension.

Generally, the portion vested cannot be reclaimed by the employer, nor can it be used to satisfy the employer's debts. Any portion not vested may be forfeited under certain conditions, such as termination of employment. The portion invested is often determined pro-rata.

Ownership in startup companies

Vesting of options is straightforward. The grantee receives an option to purchase a block of common stock, typically on commencement of employment, which vests over time. The option may be exercised at any time but only with respect to the vested portion. The entire option is lost if not exercised within a short period after the end of the employer relationship. The vesting operates simply by changing the status of the option over time from fully unexercisable to fully exercisable according to the vesting schedule.

Common stock grants are similar in function but the mechanism is different. An employee, typically a company founder, purchases stock in the company at nominal price shortly after the company is formed. The company retains a repurchase right to buy the stock back at the same price should the employee leave. The repurchase right diminishes over time so that the company eventually has no right to repurchase the stock (in other words, the stock becomes fully vested).

Beginning in the 1990s, vesting periods in the United States are usually 3–5 years for employees, but shorter for board members and others whose expected tenure at a company is shorter. The vesting schedule is most often a pro-rata monthly vesting over the period with a six or twelve month cliff. Alternative vesting models are becoming more popular including milestone-based vesting and dynamic equity vesting.

Profit sharing plans

Profit-sharing plans are usually vested in ten years, although in some cases a plan may serve essentially as a pension by allowing a limited amount of vesting should the employee retire or leave on good terms after an extended period of employment.