Resting & Vesting Guide

Understanding Employee Stock Options

Employee stock options (ESOs) have become a common part of compensation packages in many companies, particularly in the tech and startup world. They serve as a powerful tool to attract and retain talented employees, align their interests with the company's success, and offer them a chance to share in the company's growth. Among the various aspects of stock options, "Resting and Vesting" is an essential concept that employees must grasp to make the most of this valuable benefit.In broad terms, the commonality between all these equity compensation plans is that they give employees and stakeholders an equity incentive to build the company and share in its growth and success.
For employees, the key benefits of any type of equity compensation plan are:

• An opportunity to share directly in the company’s success through stock holdings
• Pride of ownership; employees may feel motivated to be fully productive because they own a stake in the company
• Provides a tangible representation of how much their contribution is worth to the employer
• Depending on the plan, it may offer the potential for tax savings upon sale or disposal of the shares

The benefits of an equity compensation plan to employers are:

• It is a key tool to recruit the best and the brightest in an increasingly integrated global economy where there is worldwide competition for top talent
• Boosts employee job satisfaction and financial wellbeing by providing lucrative financial incentives
• Incentivizes employees to help the company grow and succeed because they can share in its success
• May be used as a potential exit strategy for owners, in some instances

What are Employee Stock Options?

Employee stock options are a form of equity compensation given to employees by their companies. They grant employees the right, but not the obligation, to purchase a specific number of company shares at a predetermined price, known as the "strike price" or "grant price," within a defined time frame. The strike price is typically set as the market price of the company's stock on the date the options are granted. This feature means that the options only hold value if the company's stock price increases over time.
The benefits of the employee stock options can be briefly described as follows (see table below):EMPLOYER BENEFITSEMPLOYEE BENEFITS"Golden handcuffs" for an employeePossibility to receive company shares at a discounted price or free of chargeIncreased employee involvement, motivation, and responsibilityGreater "attachment" to the companyOpportunity to improve the company's performanceThe "good feeling" of becoming a business owner (even if it means being a minority shareholder)Funds are not needed (or less needed) to promote employees through bonuses, “welfare” packages, etc. neither „today“ nor „tomorrow“Smaller companies have a greater competitive opportunity to attract "hard-to-afford" employees, while larger companies - retain existing employees, who create high added value for the company.
The negative side of the options is related to the changes in the shareholder structure and the possible influence on the shareholders’ decisions. In many cases, existing shareholders do not usually lose a controlling share package because the employee is given an insignificant number of shares, but each case is individual.



Vesting: The Gradual Process of Ownership

Vesting is the process by which an employee gains ownership of the granted stock options over time. It is implemented as a mechanism to encourage employees to stay with the company and contribute to its long-term success. Vesting prevents employees from exercising their stock options immediately after they are granted, ensuring that they have a stake in the company's future performance.A typical vesting schedule spans several years, with employees earning a percentage of their options each year, quarter, or month. For instance, a common vesting schedule might be "4-year vesting with a one-year cliff." This means that an employee will need to stay with the company for one year before earning any options (the cliff period), after which they will vest in 25% of their total options and continue to vest an additional 1/48th of the options each month thereafter.
Many employers offer a variety of benefits for their employees. One such benefit is a vesting schedule, which is an incentive program that provides increasing levels of ownership over employer-contributed funds and assets. Understanding the benefits and functions of vesting schedules could help you make an informed decision about which type of vesting schedule is optimal for your organization.
In this article, we define vesting schedules, discuss how they work, explain vesting completion and cliffs, list the different types of vesting schedules and offer a list of tips to help you choose an optimal vesting schedule for employee retirement and investment needs.

• Employers can use vesting schedules as an incentive to retain employees. 
• Vesting schedules can manifest in the form of retirement accounts or stock options.
• Vesting schedules give employees partial ownership of employer-contributed funds over a predetermined period of time, which then turns into full ownership after the period concludes. 

Resting: Exercising Your Patience

Once the stock options vest, employees can exercise their right to buy the company's stock at the predetermined strike price. However, they are not obligated to do so immediately. The decision to exercise is primarily influenced by the current market price of the company's stock. If the stock price is higher than the strike price, employees may choose to exercise their options and buy the stock at a discount, with the potential to sell it later at the market price and make a profit.
However, there's a crucial consideration: taxes. Exercising stock options often triggers a tax event, as the difference between the strike price and the market price is considered taxable income. To avoid unnecessary tax burdens, employees can opt for "resting" their options, meaning they delay the exercise until a more opportune time.
Advantages of Resting and Vesting:

1. Reduced Tax Impact: By choosing to rest their options, employees can defer the tax liability until they decide to exercise and sell the stock. This can be advantageous, especially if they believe the stock price will continue to rise in the future.
2. Risk Mitigation: Stock prices can be volatile, and the market may experience downturns. Resting and vesting allows employees to wait for more stable or favorable market conditions before exercising their options.
3. Loyalty and Long-Term Commitment: Vesting encourages employees to stay with the company for an extended period. The longer they remain, the more options they accumulate, reinforcing their commitment to the organization's growth.
4. Aligning Interests: Resting and vesting align the interests of employees with those of the company and its shareholders. As employees become partial owners of the company, they have a stronger incentive to contribute to its success.

Risks and Considerations
While resting and vesting can be advantageous, there are some risks and considerations employees should keep in mind:

1. Stock Price Volatility: Stock prices can be unpredictable, and there's always the chance that the market price may decrease, resulting in options losing value.
2. Leaving the Company: If an employee leaves the company before their options are fully vested, they may forfeit the unvested options.
3. Tax Rules and Risks: Tax laws and regulations related to stock options can be complex and subject to change. Employees should seek professional advice to understand the tax implications fully.
4. Diversification: Relying too heavily on company stock can expose employees to concentrated risk. Diversification is essential for a well-balanced investment portfolio.

Resting and vesting are vital concepts to comprehend for employees who receive stock options as part of their compensation package. While they provide an excellent opportunity to participate in the company's growth, employees must carefully evaluate their financial situation, tax considerations, and market conditions before deciding when to exercise their options. Seeking advice from financial advisors or tax professionals can be instrumental in making informed decisions that align with their long-term financial goals.
As with any investment decision, prudence and patience are key. Resting and vesting can be a rewarding path towards building wealth and fostering loyalty to the company, but it's crucial to approach it with a clear understanding of the risks and benefits involved.
Disclaimer: The information in this blog is for informational purposes only and should not be construed as financial or tax advice. Employees with stock options should consult with a qualified financial advisor or tax professional before making any investment or tax-related decisions.