Vesting is the right to own or buy an asset or benefit at a future date. It can be transferred without any cost or at a predetermined price. The asset or benefit is generally termed as ‘vested interest’
How vesting works
Vesting is a commonly used tool by businesses to retain employees for longer periods. Employee turnover is a significant problem for every type of business. Companies incur a great deal of cost to hire and train new employees, so it’s more efficient in terms of both cost and operations to retain existing employees. Vesting is a commonly used instrument to achieve that goal.
The compensation of employees can include “vested interests.” Employees earn shares of the company or stock options as a part of their compensation. Employees can then “vest” those options after a certain period of time. While employees may earn a number of shares per year, they receive ownership of the accumulated shares only after a specified number of years of employment with the company.
The only difference between earning shares and stock options is that the shares are not automatically transferred to the employee. Usually, employees have to pay a predetermined price, and they can only exercise the purchase on a future date mentioned in the employment contract. Employers can also implement vesting for pension contributions to investment vehicles like a 401k.
Companies use vesting to give employees a stake in the company’s success. Since part of the compensation is in the form of shares or stock options, they increase in value only if the company’s total market value increases. This results in two primary benefits:
Employees work harder to improve the business and the company’s standing. If the company’s value increases, the value of the shares vested to the employees also increases.
Companies can retain employees for a longer period of time. The employee has more motivation to stay with the company at least until the shares are vested.
Vesting can also be part of an inheritance. The person inheriting an asset takes control of it only after the vesting period.
It’s a common legal tool employed when transferring an inheritance to minors. The vesting clause may state that the child gains control of the asset only after he/she turns 18. Vesting can also be part of real estate transactions even when there are no inheritances involved, with varying terms and conditions outlined in the contract.