Monthly vs yearly vested ESOPs: What makes them different for both employers and employees?

ESOP programmes are charted to allow every employee to earn ownership in the company through stock options. A lower vesting period as in monthly vesting policies boosts the employees’ morale, thus, promoting their contributions and commitment towards their employer company.

Many candidates joining for new jobs are content with the employee stock ownership plan (ESOP) benefits offered by their employers. However, many of them ignore asking about the vesting period not realising how the length of the tenure decides how long the employees must wait before gaining access to the rights that attach to the options or shares after they are issued ESOPs.

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There is no legal reference to decide how long the vesting period should be. Some companies deliberate on a substantial vesting period to keep their employees from looking for suitable alternatives. Also, the prolonged stay of the employees interested in encashing their ESOP benefits ensures that the company meets its commercial objectives over the period. However, too long a vesting period can cause employees to feel disillusioned and switch to competitors’ companies offering better payouts.

A tectonic shift in ESOPs vesting period

There is no slated ESOP vesting period. Most companies have kept it between 12 months and five years in sync with industry standards. However, times have changed with many companies now limiting the vesting period to a few months as a lucrative and alternative measure to higher packages and steep appraisals. For example, in June 2022, Unacademy shifted to monthly vesting of ESOPs as opposed to their regular yearly vesting option.

The idea behind the company redesigning the ESOPs policy was to provide better benefits to employees. The revised policy will allow ESOPs to be vested on a month-to-month basis post a one-year cliff period. After the cliff period ends, 25 percent of the options will be vested. After that, the remaining options will be vested every month over the next three years. However, this is only applicable to ESOPs issued after April 15, 2022, thus, benefiting the employees recently employed by the company.

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The new policy involving a shorter ESOPs vesting period is being termed as highly employee-centric with some people even stating how the revised ESOPs policy will encourage more employees to stick to the company for longer periods, thus, enabling higher output.

Unacademy is not the first company to have made a move in this direction. Before this, the famous B2B e-commerce platform Udaan informed in February 2022 how their employees would be able to tender their shares every quarter instead of every year.

Explaining the idea behind removing the cliff vesting period for all ESOPs, one of the officials at Udaan stated how the one-year cliff destroyed the employees’ faith in their employer companies, thus prompting them to revamp their ESOP policy.

Time-based vesting

Most companies have mandated a three-to-four-year vesting period, with many now lowering the tenure to no more than a year. However, longevity with the company used to extract a long-term commitment from employees has now changed to either performance-based vesting or partial vesting regularly after every few months. 

For example, some companies allow 100 share options to vest at the completion of every year of employment over a four-year period. This way, companies encourage their new employees to continue working with the company for a minimum period before their allocated options can be exercised.

READ MORE: Why shouldn't you be misled by startup ESOP options

Considering how companies assess their employees’ performance after every four or six months, the monthly vesting of ESOPs can also be related to performance-based vesting. The vesting schedule is thus set based on certain targets to be met or achieved. This could be based on the achievement of the company, team, or individual performance objectives or key performance indicators (KPIs). This also explains why many companies have moved on to monthly or periodic vesting from their yearly vesting standards.

The tax calculation is repetitive and hence arduous on income from the monthly vesting of ESOPs. This is different from yearly vesting that involves less paperwork due to less frequency of apprising on stock valuation. In the monthly vesting, you have to calculate taxes every time you exercise your option.

Innovation is the key to solving many problems, thus, giving way to hybrid vesting practices. These days, companies are using ESOP schemes to balance employee performance and commitment to the company. New ESOP schemes now combine both time-based and performance-based vesting, thus, justifying employers’ increasing affinity toward monthly vesting policy as opposed to the earlier standardised yearly vesting policy.

BM Singh, ESOP Expert & Managing Partner, BMSA Consultancy

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