Let’s imagine that you are offered a fab new job in the US. Unlike in Israel, in the US, salary is quoted on an annual basis and not on a monthly basis. Now, that is an impressive number, right? See, I told you it was a fab job.
So, you go into work on the first day. You spend some time with the human resources manager, filling out all the paperwork. (The US is BIG on paperwork. We are talking stacks). At last, you are done! You are now officially an employee! The HR manager reaches into her desk, pulls out a giant stack of cash and hands you your entire annual salary.
Well, no. It’s not that fab a job. 🙂
What will really happen is that you will receive that annual salary in 12 equal monthly installments, as you earn it. If you don’t work the entire year—say you leave after six months—in total you will receive 50% of the annual salary, for the portion of the year you worked. The remaining six months will be forfeit—that is, you won’t earn it and will have no rights to it.
That, in a nutshell, is vesting. It’s “earning”, that is receiving the rights to something, either over time or based on meeting some other condition.
Vesting terms appear frequently in agreements in which rights to equity are granted, such as employee share option (ESOP) grants, founders agreements or restricted share agreements. Unlike salary, which tends to be quoted on an annual basis at most, vesting periods are frequently longer. In addition, while salaries tend to be earned evenly over the course of the year, the vesting schedule (that is, the rate at which the rights are received over the course of the vesting period) may vary over time. For example, ESOP grants often have a four year vesting period, with 25% of the options earned only after 12 months and the remaining options earned in 12.5% chunks over the next 3 years. Alternatively, you might see a vesting schedule where 100% of the options vest on the closing of an investment of a certain amount, or on an exit event.