When a security is subject to timing restrictions before it becomes unconditionally unrestricted, these timing restrictions are referred to as a vesting period. Vesting periods tend to apply to employee stock option plans and retirement benefits.
Like other vesting conditions, a vesting period makes securities vulnerable in certain ways. For example, if an employee is offered a stock option plan but the securities within that plan will not vest for five years, an employee may be faced with the choice of remaining with the company for the duration of the vesting period or risking forfeiture of the stock option plan. If that worker leaves the issuing company before the vesting period is complete, not only does the worker forfeit his or her rights to the securities, the company may buy the shares back at the original issue price. Why can’t an employee sell or otherwise transfer these securities before the vesting period is complete? Vesting periods are designed to reward loyalty (and to some degree, patience). If an employee could sell or transfer the securities at any time, the existence of the stock option plan would not function to reward company loyalty.
Once a vesting period is complete, if an employee has not terminated his or her relationship with the issuing company, full ownership rights are conferred and the securities can no longer be revoked. A vesting period may be graded (benefits gradually conferred over a number of years) cliff (only when fully vested is an employee entitled to benefits in question) or accelerated (usually only applicable in the event of an acquisition).
Spouse: “I’ve been offered a stock option plan as part of the benefits package for my new job.”
Husband: “That’s great! Can we sell some shares now and take the vacation we’ve been trying to plan?”
Spouse: “The vesting period on the plan is five years. We can go on vacation in five years.”
Husband: “If we can’t find a way to go on vacation soon, you might not have a husband in five years.”