Vesting Schedule

Vesting is the point at which equity that has been promised becomes earned. For a stock option, the CRA describes vesting as the time when the employee can first exercise, sell or transfer the rights. Before that, the holder has a contingent right that normally disappears if they leave. The vesting schedule sets out how much vests and when.

Vesting is a contract term. It is set by the employee stock option plan the board adopts and by each grant agreement, and the board can vary it grant by grant within what the plan allows. Most schedules are time-based. Some are milestone-based, vesting when a product ships or a revenue target is met, which works only if the milestone is defined precisely enough to avoid a dispute.

Founders are usually different. They typically hold issued shares that the company can buy back if they leave early, rather than options; that structure is reverse vesting, and our article on why founder agreements matter explains why investors expect it.

The cliff is a minimum service period before anything vests. On a four-year schedule with a one-year cliff, an employee who leaves at month 11 keeps nothing; one who stays to month 12 vests 25% at once, and the balance then vests in equal monthly instalments over the next 36 months. For a grant of 48,000 options:

Common variations include quarterly instead of monthly vesting, shorter schedules for advisers, no cliff for consultants on short engagements, and a vesting start date earlier than the grant date to credit service before the plan existed. Whatever the choice, the grant agreement should state the vesting start date, the cliff, the instalment frequency and how partial months are treated. Lamba Law's free vesting calculator shows month by month how a given term, cliff and acceleration play out, and every grant should be reflected on the company's cap table.

Acceleration means some or all unvested equity vests early when a defined event happens.

Single trigger. One event, usually a sale of the company, accelerates vesting. It rewards holders at exit, but it removes the retention incentive just when a buyer needs the team to stay, so buyers often reduce the price or insist on new retention grants.

Double trigger. Two events are needed: a change of control and, within a set period after closing (often 12 months), a termination without cause or a resignation for good reason. It protects employees who lose their role because of the sale while leaving the buyer an incentive to keep everyone else. Double trigger is the more common market compromise.

Partial acceleration, such as 25% or 50% of the unvested balance, is another middle ground. The plan should define change of control with care, because the definition decides whether a merger, a sale of substantially all the assets or a large financing counts; see change of control clause. The plan should also say what happens to unvested options if a buyer will not assume them: board discretion to accelerate, cash out or cancel.

Leaver terms decide what a departing holder keeps. A typical plan provides that unvested options terminate when service ends, vested options can be exercised for a limited window afterwards, often 90 days, and all options lapse on a termination for cause. Some plans treat good leavers, such as those who die, become disabled or are dismissed without cause, more generously than bad leavers.

The date service ends matters more in Ontario than many plans assume. In Matthews v. Ocean Nutrition Canada Ltd., 2020 SCC 26, the Supreme Court of Canada held that a constructively dismissed employee was entitled to damages for a sale bonus that would have been paid during his reasonable notice period, because nothing in his contract clearly removed it. The Court asked two questions: would the employee have been entitled to the payment during the reasonable notice period, and does the contract or plan clearly and unambiguously take that right away? Stock options and other equity awards raise the same questions. Clear wording the employee has accepted can work: in Battiston v. Microsoft Canada Inc., 2021 ONCA 727, the Court of Appeal enforced stock award terms providing that unvested awards do not vest if employment ends for any reason and that the right to vest is not extended by any notice period, because the employee had confirmed his acceptance of those terms every year for 16 years, even though he chose not to read them. Vague wording, such as a bare reference to the termination date or to active employment, risks damages for options that would have vested during the notice period.

Plans should define the termination date for vesting purposes in clear terms, deal separately with the notice period under the Employment Standards Act, 2000, and be drafted together with the employment agreement rather than in isolation.

Vesting an employee stock option is generally not a taxable event. Under section 7 of the Income Tax Act, the employment benefit, the difference between the value of the shares and the exercise price, is taxed in the year the option is exercised or, if a Canadian-controlled private corporation (CCPC) granted the option to an employee dealing with it at arm's length, in the year the shares are sold. Our entry on stock option taxation in Canada explains that deferral, the one-half deduction and its conditions.

Vesting matters for tax in one case. For options granted on or after July 1, 2021 by an employer that is not a CCPC and has revenue above $500 million, alone or as part of a consolidated group, options vesting in a calendar year are eligible for the one-half deduction only up to $200,000, measured by the value of the underlying shares at grant, as the CRA's security options guidance explains. Because the limit applies one vesting year at a time, the shape of the schedule decides how much of a large grant qualifies.

Clearbeam Health Inc., an Oakville medical-device startup, hires Tomasz Kowalczyk as a senior engineer and grants him 48,000 options at $0.40 per share. The schedule is four years with a one-year cliff, then 1,000 options a month, with double trigger acceleration: a change of control plus a termination without cause within 12 months after closing. His colleague Grace Mensah receives the same terms but resigns after 11 months, before the cliff, and forfeits all her options.

Twenty-two months into Tomasz's schedule, a larger Canadian device maker buys Clearbeam. He has vested 22,000 options; the other 26,000 do not accelerate at closing, because the sale alone is only the first trigger, and the buyer assumes the plan on the same schedule. Five months later his role is eliminated and he is terminated without cause. By then 27,000 options have vested, and the second trigger fires within the 12-month window, so the remaining 21,000 vest immediately. Tomasz has 90 days under the plan to exercise all 48,000.

Had the plan used single trigger acceleration, all 26,000 unvested options would have vested at closing, a cost the buyer had told Clearbeam's founders it would have deducted from the purchase price.