What Is ‘Vesting’ in Private Equity-Owned Companies?

Vesting is the process of accruing a long-term interest in the equity of a company, most commonly in retirement benefit plans or stock incentives. Many vesting plans allow employees to gain increasing value over a period of time, commonly three to five years, until 100% of the value is vested. 

A common schedule of vesting goes like this: an employee receives 100 restricted stock options the first year, with 25 units vesting the second year, 25 units vesting the third year, and so on until, five years later, the entire 100 units are vested. If the employee left the company after three years, only 50 units would have vested, and the rest would retain no value and would remain with the company. 

Vesting in Private Equity

Many private equity firms utilize vesting schedules to encourage alignment between the sponsor, the portfolio company, and their executives. It further encourages long-term incentives for their portfolio companies to succeed.

For more on this subject, please see Co-Investment Can Be a Powerful Litmus Test for C-Suite Leaders. 

There are several types of vesting often implemented by private equity firms, including deal-by-deal, fund-based, and tranche-by-tranche vesting. Some firms will use a hybrid of these models.

Deal-by-Deal Vesting

This model starts the vesting clock the day the deal is signed and vests options in installments over time. The most common model is a four-year time period with 20% vesting each year. 

Fund-Based Vesting

Carry values are shared by the founders and key owners. Fund-based vesting must be constructed ...