Understanding Vested and Unvested Shares

Explore the key differences between vested and unvested shares, their tax implications, legal considerations, and their role in employee retention.
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3 mins read
23-May-2025

What are vested shares?

Vested shares are those that an employee fully owns after meeting specific conditions, such as completing a vesting period or achieving performance milestones. Employees can sell, transfer, or retain these shares, enjoying full ownership rights, including voting and dividends. Vested shares are often part of compensation plans to reward long-term contributions and align employee interests with the company’s success. Their value depends on the company’s market performance, offering significant financial benefits to employees. Companies utilise vested shares to encourage retention, ensuring employees remain committed for extended periods. Once vested, these shares serve as a tangible reward for an employee's dedication and efforts within the organisation, fostering a sense of ownership and loyalty.

What are unvested shares?

Unvested shares are stock options that employees have been granted but do not yet own. Ownership is contingent on fulfilling specified conditions, such as completing a certain period with the company or meeting performance targets. These shares cannot be sold, transferred, or exercised until they vest. Unvested shares act as an incentive for employees to stay committed to the organisation, aligning their interests with long-term business goals. If employees leave the company before completing the vesting period, unvested shares are typically forfeited. While they do not provide immediate financial benefits or ownership rights, they represent a promise of future rewards, motivating employees to perform and contribute consistently.

Difference between vested and unvested shares

Aspect Vested Shares Unvested Shares
Ownership Fully owned by the employee. Not yet owned by the employee.
Transferability Can be sold or transferred. Cannot be sold or transferred.
Voting Rights Include voting rights and dividend entitlements. No voting rights or dividend entitlements.
Forfeiture Retained after leaving the company. Typically forfeited if the employee exits prematurely.
Financial Benefit Immediate financial benefit upon sale. No financial benefit until vested.
Loan Against Shares
Loan Against Mutual Funds

Vesting schedules: Time-based vs. milestone-based

  1. Time-based vesting: Employees gain ownership over shares gradually over a specified period, often with yearly increments or monthly distributions.
  2. Milestone-based vesting: Shares vest when employees achieve specific goals or complete predefined projects.
  3. Combination vesting: Employers may use a mix of both schedules to balance long-term commitment and performance incentives.
  4. Flexibility: Milestone-based vesting provides more control, while time-based vesting ensures predictable retention strategies.

Common vesting cliffs and acceleration clauses

  1. Vesting cliffs: Employees earn no shares during an initial period (usually one year), after which a lump sum vests.
  2. Graded vesting: Shares vest incrementally after the cliff period.
  3. Acceleration clauses: Allow immediate vesting in specific circumstances, like a company sale or employee termination without cause.
  4. Retention benefit: These clauses ensure fair treatment while motivating long-term commitment.

Tax implications of vested vs unvested shares

  1. Vested shares: Taxable as a perquisite when exercised, with additional capital gains tax on sale profits.
  2. Unvested shares: Not taxable until vested or exercised.
  3. Capital gains: Tax rate depends on the holding period of shares.
  4. Planning importance: Employees must understand tax obligations to maximise financial benefits.

Vested shares and employee retention

Vested shares are an effective tool for retaining top talent. They incentivise employees to stay with the company, as ownership rights are tied to completing a vesting schedule. By offering these shares, employers align employee interests with business growth, ensuring a committed and motivated workforce. Vested shares also foster a sense of belonging, enhancing job satisfaction and reducing attrition rates, particularly in competitive industries.

Impact of leaving the company: Vested vs unvested

Employees retain vested shares after leaving a company, allowing them to exercise or sell these options. In contrast, unvested shares are typically forfeited, resulting in a loss of potential financial benefits. This distinction impacts an employee’s decision to resign, especially if a significant portion of their compensation comprises unvested shares. Understanding the terms of share agreements is crucial when planning an exit.

Vested vs unvested shares: Legal considerations

Vested and unvested shares come with distinct legal implications. Vested shares provide employees with full ownership rights, including voting, transfer, and dividends, safeguarded under employment agreements. Unvested shares, however, remain conditional and may be forfeited upon termination or resignation. Employees must review share agreements to understand their rights, including provisions for acceleration, cliffs, and dispute resolution, ensuring informed decisions.

Frequently asked questions ‌
Faq info text Done

What is the difference between vested and unvested shares?
Vested shares are fully owned by the employee, allowing transfer or sale, while unvested shares are conditional on meeting tenure or performance milestones. Vested shares offer ownership rights, whereas unvested shares are forfeited if criteria remain unmet.

What happens to unvested shares if I leave the company?

Unvested shares are typically forfeited when an employee resigns or is terminated before completing the vesting period. However, company policies may vary based on agreements or circumstances of the exit.

Are there tax implications for vested vs unvested shares?
Vested shares are taxable when exercised as perquisite income, with additional capital gains tax upon sale. Unvested shares have no tax implications until they vest or are exercised.

Do unvested shares have any value?

Unvested shares do not hold realizable value for the employee. They represent a future promise, not actual ownership. If you leave the company before vesting, you typically forfeit those shares entirely.

What is a vesting cliff?

A vesting cliff is the minimum period you must stay with the company before any ESOPs start vesting. For example, in a 1-year cliff, no shares vest until you complete one year of employment.

What are common types of vesting schedules?

The most common vesting schedule is 4 years with a 1-year cliff, followed by monthly or quarterly vesting. Some startups may offer accelerated vesting on exit events or milestone-based vesting for key hires.

When can I sell my vested shares?

You can sell your vested ESOPs during a liquidity event like an IPO, acquisition, or company buyback. Otherwise, they remain illiquid, and their value can only be realized when such an event occurs.

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