Cliff Vesting Vs Graded Vesting

When you join a company, the perks on paper often look exciting stock options, retirement benefits, and other rewards. But here is the catch: you do not get them all at once. They come with a vesting schedule, a way of deciding when you actually own these benefits.

Now, there are two common types: cliff vesting and graded vesting. Both have their own rules, pros, and downsides. The real question is which one works best for you as an employee? Let us break it down in simple terms.

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What is cliff vesting?

Cliff vesting is like an all-or-nothing deal. You do not get partial ownership of your benefits in the early years. Instead, you become 100% entitled after hitting a specific milestone say, 2 or 3 years.

Example: If your company has a 3-year cliff, and you leave at 2 years and 11 months, you walk away with nothing. But stay until the 3-year mark, and you get it all at once.

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What is graded vesting?

Graded vesting is more flexible. You start earning partial ownership of your benefits year by year, instead of waiting for a long cliff.

Example: If you are granted 100 shares over 5 years, you might vest 20 each year. So, even if you leave after 2 years, you’ll still own 40 shares.

Differences between cliff vesting and graded vesting

Examples of cliff vesting and graded vesting

• Cliff vesting example: An employee is granted 200 shares with a 4-year cliff. They get nothing if they quit at 3 years, but 100% of shares if they stay till 4 years.
• Graded vesting example: An employee is granted 200 shares over 5 years. They vest 40 each year. If they quit at 3 years, they still keep 120 shares.

For more details on the vesting date meaning and how it impacts your benefits, refer to the linked article on vesting date meaning.

Advantages of cliff vesting

Here are advantages of cliff vesting:

• Clear milestones: Employees receive full benefits at once after a set period, creating a clear incentive to stay with the company.
• Retention tool: One of the possible ways of encouraging employees to remain with the company for a significant period before they can access benefits, reducing turnover.
• Simpler administration: Easier for companies to manage as employees either receive all or none of the benefits.

Disadvantages of cliff vesting

Here are disadvantages of cliff vesting:

• All-or-nothing: Employees who leave before the vesting date forfeit all benefits, which can be discouraging.
• Delayed rewards: Employees may feel demotivated if they don’t see any incremental benefits over time.
• Potential for loss: Employees might leave just before the vesting date, losing out on all benefits, which could impact morale.

Advantages of graded vesting

Here are advantages of graded vesting:

• Gradual reward: Employees earn their benefits incrementally, which can motivate them to stay engaged over time.
• Reduced risk for employees: Employees who leave early still retain some benefits, reducing the feeling of losing everything.
• Flexibility: Allows for a more flexible reward structure that can align with long-term employee goals.

Disadvantages of graded vesting

Here are disadvantages of graded vesting:

• Complex administration: Tracking incremental benefits over time can be more complex and require more management effort.
• Weaker retention: Since employees can access some benefits earlier, it may not be as strong a retention tool as cliff vesting.
• Reduced sense of milestones: Employees may not feel as strong of an incentive to stay for a long period compared to a cliff vesting schedule.

How do vesting schedules work in India?

In India, vesting schedules are commonly used in Employee Stock Option Plans (ESOPs) and retirement schemes like the National Pension System (NPS). For ESOPs, companies typically follow a minimum one-year cliff, as mandated by SEBI guidelines, after which shares vest gradually often over 3 to 5 years. For retirement benefits like provident funds or pensions, vesting depends on the type of plan and employer policy, but long-term service is usually required. Vesting ensures employees earn their benefits over time, encouraging retention and loyalty.

How to choose the right vesting schedule for your employees

The right vesting schedule depends on what you want to achieve as an employer.

• Cliff vesting: Cliff vesting is best if your priority is long-term retention. It encourages employees to stay for a fixed period before they can access benefits.
• Graded vesting: Graded vesting works well if you prefer offering steady rewards that grow over time, so employees feel valued even if they leave early.

Some companies even combine both, starting with a short cliff followed by graded vesting to strike a balance between retention and flexibility.

Why vesting schedules matter for ESOP holders?

For employees, vesting is not just about timelines—it’s about building long-term wealth. Whether your company follows cliff or graded vesting, what matters most is how you manage your vested stock options.

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Conclusion:

When it comes to cliff vesting vs graded vesting, there is no one-size-fits-all answer. Cliff vesting motivates employees to stay longer, while graded vesting offers gradual rewards and flexibility. For employees holding ESOPs, what matters most is not just the schedule but how you exercise your shares.

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