How Equity Vesting Works
Whether it’s applied to phantom equity via the MARE, restricted stock units (RSUs), or incentive stock options (ISOs), vesting generally works the same way. It is a mechanism that allows an employee to earn equity over a specified period of time, or to collect equity over the course of meeting certain milestones. Incremental earning and working towards a final equity award is meant to be a retention mechanism, incentivizing employees to stay with the company at least until they are fully vested.
The Two Types of Vesting Schedule
Vesting schedules outline the timeframe that employees will earn shares of equity. There are two primary types of vesting schedules, though some companies combine them into a third hybrid schedule.
Time-based vesting:
Time-based vesting means employees earn options or shares over a fixed period of time. This schedule usually includes a “cliff,” or the period of time required to pass before a certain portion of shares vest. After the cliff passes, the remaining equity usually vests incrementally monthly, quarterly, or annually.
Milestone-based vesting:
Milestone-based vesting is centered on employees hitting specific performance goals or other company-chosen milestones.
Monthly, Annual and Cliff: How Often Equity Actually Vests
Time-based vesting still leaves one decision: how often the equity actually vests. The cadence you choose changes how an employee experiences the plan far more than the total length of the schedule does.
Monthly vesting releases a slice of the award every month once the cliff has passed. It is the most common cadence in equity vesting because it keeps the award visibly moving, and a departing employee’s balance can be calculated to the month without argument.
Annual vesting releases a block once a year. It is simpler to administer and it creates a much sharper incentive to stay through each anniversary, because an employee who leaves eleven months in forfeits the whole year. Quarterly vesting sits between the two, and is usually chosen when monthly administration is more work than the plan is worth.
A cliff can sit in front of any of these. A one-year cliff followed by monthly vesting is the most widely used company vesting structure, and it does two jobs at once: nothing vests until someone has been there long enough to be worth retaining, and after that the award accrues steadily rather than in annual jumps.
There is no single correct answer. Annual vesting suits a business where the roles are stable and the administration is the constraint. Monthly vesting suits a business competing for people who compare offers, because a monthly schedule is what most candidates will have seen elsewhere.
The MARE’s phantom stock tool (Modern Agreement for Rewards and Equity) can be utilized to implement either a time-based vesting schedule or a milestone-based one. However, the vast majority of Reins customers choose time-based vesting.
One of the simpler options (in terms of payout and taxation) that the MARE offers is the necessity for employees to be employed at the time of payout. In this optional scenario, if an employee is fully vested, they cannot take their shares with them when they leave the company. They must be paid out while they are employed (assuming a triggering event, like the sale of the company, occurs). Here’s an example of a standard MARE vesting schedule:
A Worked Example
Employee A is allocated 1,000 units of phantom stock on January 1, 2024. The vesting schedule is time-based, with 25% vesting after the first year and the remaining 75% to vest evenly every month over the following three years. That means that on January 1, 2025, Employee A will have vested 250 units of phantom equity. After that date, Employee A will vest 20.83 units every month for the next 36 months, until they are fully vested after four years.
A vesting schedule only does its job if the equity behind it has a number attached. Get a valuation and see what the shares you are about to promise are actually worth.
Bottom line: why vesting matters
Small business owners should remember that vesting is a strategic tool that aligns company success with employee retention and financial interest. Tying an important part of compensation and ownership to long-term commitment to the company should be mutually beneficial.
