In this fourth installment of our Pre-IPO Guide to ESOPs, we focus on a key decision - structuring vesting schedules and criteria for pre-IPO grants.

Vesting criteria is a powerful lever in shaping employee behavior, retention, and performance. A well-structured vesting schedule ensures alignment with company goals while also optimizing the level and pattern of ESOP expenses.

Many companies default to a 4-year service-based vesting schedule (25% annually) as it offers simplicity, a reasonable earning period, and equal weightage to each year of service. While effective in many cases, it may not always be the best fit - especially at the Pre-IPO stage, where alignment with IPO readiness and value creation is key. Rather than following a one-size-fits-all approach, companies should assess and tailor their vesting structure to best support their IPO journey and long-term objectives.

Here are the key considerations to help you get it right:

Balancing Pre-IPO and Post-IPO Vesting
  • - Aim for at-least 75-80%of grant to be vested before or at IPO to maximise employee wealth creation at IPO.
  • - Partial accelerationmay be considered based on IPO success or key milestone achievements.
  • - Retain a portion for post-IPO vesting to encourage employee continuity, supplemented with additional post-IPO grants.
Performance vs. Service Linkage
  • - ESOPs are inherently linked to company performance; however, pure service-based vesting may also lead to ‘Rest and Vest’ behavior.
  • - Milestone-based vesting- such as achieving revenue / profitability targets or market capitalization / share price targets - for Leadership ESOPs may help better align with shareholder / investor expectations.
  • - A hybrid model combining service and performance-based vesting may help balance retention with performance-driven incentives.
Impact on Income statement
  • - Vesting criteria directly impacts thelevel and timing of ESOP charges on the income statement.
  • - Understand year-on-year ESOP costimpact to ensure it remains manageable pre- and post-IPO.
  • - Evaluate accelerated vesting clauses for their financial and disclosure implications.

Aligning ESOP vesting with IPO objectives ensures employees remain motivated, invested, and committed beyond the IPO. A well-planned vesting structure not only strengthens retention and accountability but also enhances investor confidence and alignment.

Should you have any comments or thoughts or feedback, please feel free to share write to us. We would love to hear from you!

Vichitra Malhotra, FIAI

Founder and Consulting Actuary

v.malhotra@veritas-india.com

+91-9372876627





 

Disclaimer: The above content has been furnished solely for information and must not be reproduced or redistributed. It should be noted that we are not soliciting any action based upon it. Also, it does not constitute any recommendation. In particular, the information above is for general purposes only and is not an advice on employee stock option solutions valuations or preference of one scheme over another. The information given above is in summary form and does not purport to be complete. We have reviewed the above and in so far as it includes information or facts, it is believed to be reliable though its accuracy or completeness cannot be guaranteed.