Companies give employees a variety of incentives to create loyalty over the long-term. One of the more popular incentives is stock in the business itself. Many organizations grant stock and stock options to employees, since the company benefits from investment and many businesses believe that employees will work harder if they know the success of their stock is tied to the success of the company. However, stock options come with limitations, such as vesting periods.
A vesting period is the amount of time an employee must wait before being able to exercise stock options. Stock options only allow employees to buy company stock at a particular price; they do not grant the stock itself, so employees must wait to earn this ability. Vesting can occur at intervals through several years, or all at once after the employee has worked for a certain amount of time, often five years or more. If the vesting period is not complete, the employee cannot exercise the specified stock options.
While vesting periods encourage the employee to remain with the company, some organizations allow what is known as an early exercise, or the ability to exercise stock options even though the vesting period is not yet complete. In this case, employees can exercise options that are not vested or have been only partially vested. This type of incentive may be the result of contract negotiations or simply an added perk that the company uses to attract skilled workers.
The benefits of an early exercise are clear. The employee does not have to wait years to buy company stock. He is also able to plan investments and act on them according to personal schedules, rather than company time frames. For the business, this means the employee will invest in the company more quickly.
Early exercises do come with a cost. An early exercise may create tax liabilities that a normal stock option plan would not, based on the type of plan the company has created. Also, stock options are primarily useful if the stock price has risen far above the set option price, allowing employees to purchase stock at a large discount. With early exercise, little time has passed and the stock will probably not have risen appreciably beyond the set option price. This lessens the value the employee receives from the incentive.