A Guide to ESOP Terms
Vesting in the context of Employee Stock Ownership Plans (ESOPs) refers to the process by which an employee earns the right to receive ownership of shares in their employer's company.
When an employer offers an ESOP, they typically grant employees the option to purchase company stock at a discounted price, or receive shares of stock as part of their compensation package. However, these shares are not immediately owned by the employee.
Instead, the shares are subject to a vesting schedule, which is a predetermined timeline that specifies when the employee's ownership in the company will become fully vested.Vesting schedules vary, but they typically span several years and involve incremental vesting. For example, an ESOP might vest over a period of four years, with 25% of the shares becoming fully vested each year. This means that after the first year, the employee would own 25% of the shares, after the second year they would own 50%, and so on, until the entire grant is vested.
Vesting schedules are designed to incentivize employees to stay with the company for a certain period of time, as they only receive ownership of the shares if they remain employed during the vesting period. They also provide a way for companies to reward employees for their long-term service and contributions to the company's success.
Under a cliff vesting schedule, an employee becomes fully vested in a specific number of shares of the company's stock after a certain period of time, known as the cliff period.
During the cliff period, the employee does not vest any shares of the company's stock. However, at the end of the cliff period, the employee becomes fully vested in a percentage of the shares.
For example, a company may offer an ESOP plan that includes a cliff period of one year and a vesting percentage of 100%. This means that an employee would not vest any shares during the first year of employment but would become fully vested in all of the shares after completing one year of service with the company.
A strike price is the fixed price at which an employee can purchase a share of stock in an Employee Stock Ownership Plan (ESOP) or stock option plan. The strike price is set when the employee receives the option to purchase the stock and remains fixed for the duration of the option period, regardless of the current market price of the stock.
The strike price is usually lower than the current market price of the stock at the time the option is granted, which gives the employee an incentive to purchase the stock at a discount and potentially realize a profit if the market price of the stock increases in the future.
For example, suppose an employer grants an employee the option to purchase 1,000 shares of company stock with a strike price of $50 per share. If the market price of the stock increases to $70 per share, the employee can purchase the shares at the lower strike price of $50 and realize a profit of $20 per share if they sell the shares at the market price of $70.
A good leaver is an employee who leaves the company under favorable circumstances, typically defined by the terms of the ESOP plan. A good leaver is usually entitled to receive the full value of their vested stock options or other ownership interests in the company.
A bad leaver is an employee who leaves the company under unfavorable circumstances, typically defined by the terms of the ESOP plan. A bad leaver may be entitled to receive a reduced value or no value at all for their vested stock options or other ownership interests in the company.
The definition of a bad leaver can vary depending on the specific terms of the ESOP plan. Generally, a bad leaver is an employee who is terminated for cause, such as for engaging in misconduct or violating company policies, or who resigns without providing sufficient notice or cause.