Have you ever received vested shares? Are they different from ordinary shares? In the past, we covered how shares are allocated, but in this article, we will answer the questions above.
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Vested shares?
A vested share is a share that the shareholder can act on. An unvested share is one which they cannot, but which they will be able to act on later. Vested share arrangements are an effective way for companies to encourage employee loyalty, help motivate co-founders to stay with a startup business and reassure investors that the co-founders are in it for the long term.
Vested share arrangements
These share arrangements usually work on a time schedule. A company delegates a set number of unvested shares to someone. However, these shares will remain unvested until a certain period has past. More often than not this period is 1 year. Once the period has past, a certain number of shares will become available, this is known as the ‘cliff’. After another year has past, more shares become available, until all shares become vested.
Although much rarer, companies can have a vested share arrangement where the delegated shares become available only when the receiver of the shares achieves a certain goal. This motivates the receiver to work harder and commit themselves more fully to the task at hand.
Example
Zelda gives Jake 100 shares in TheBestCompanyEver. However, Zelda tells Jake that these 100 shares cannot be used right away. Therefore, the shares remain unvested in Jake. Zelda reassures Jake that after 1 year, Jake can act on 20 of these shares and the next year another 20 and so on, until all 100 shares become vested in Jake. Jake now has an incentive to continue working for TheBestCompanyEver, at least for the next 5 years, so that all his 100 shares can be used.
Why use vested shares?
There are 3 main benefits for companies to issue vested shares. These are to:
- Encourage loyalty;
- Reduce costs;
- Promote confidence amongst investors.
Loyalty
Employees, co-founders and even investors will be more loyal to the company, if they have vested shares, as they have a reason for staying on with the company. If they leave before all shares are available, then they will lose them and they go back to the company.
Costs
There are many ways to reward people in companies. These can take the form of bonuses or other cash rewards. Especially if you are running a startup, you do not have great cash flow and cannot afford to divvy out bonuses. Therefore, organising vested shares arrangements help keep loyalty without damaging the startup’s cash flow.
Confidence
Investors will be more likely to invest in a startup if they know the co-founders are committed to seeing it succeed. Issuing vesting shares to oneself or their co-founder is a great way of promoting confidence in investors, as they know the founders have more incentive to stay with and increase the value of the company.
Knowing whether a vested share arrangement is right for your business or if you are someone receiving one, knowing what questions to ask is important. For this reason, you should seek legal advice, so that you know exactly what you are doing.
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