Employee Stock Options Plan

What is an Employee Stock Option Plan?

An Employee Stock Option Plan (ESOP) is an equity compensation companies offer to their employees and executives. Rather than issuing shares of stock, the company offers derivative options on the stock. These options are similar to regular call options in which they give the employee the right to purchase the company’s stock at a set price for a set period.

ESOPs have traditionally been reserved for senior employees, but many companies, particularly start-ups, are now extending them to all levels of the organisation.

An exercise price, as well as a vesting and exercise period, are all included in ESOPs. For example, assume your employer offers you ESOPs or the option to purchase its stock at Rs.500 per share for the next two years. The vesting period is the one year between when you first get the right to buy stock and when you get it. The exercise period is a two-year window in which you can purchase them at any time. You lose your right to buy the shares once the exercise period is over.

Employees who qualify for an ESOP include:

• A company’s employee in India or elsewhere in the world
• A full-time or part-time director of the company, but not an independent director
• A permanent employee or director of an associate company, a holding company, or a subsidiary company in India or outside India
• The above is subject to the conditions of the company made for eligibility

Purpose of Employee Stock Option Plan

Employee stock ownership plans (ESOPs) are given out to employees based on their service length or performance. As a result, it helps the company achieve the following objectives.

1. After making employees shareholders, it serves as a source of motivation. They become more accountable to the company when they own stocks, and they perform better to increase the value of the company’s shares.

2. It aids employers in retaining employees and ensuring better work performance.

Benefits of Employee Stock Option Plans

1. Due to the lock-in period for exercising the right to purchase the shares, ESOPs can be considered a retaining instrument for small businesses. As a result, a company’s workforce can be kept. If an employee chooses this option, he must complete the lock-in period before exercising it.
2. Employees gain a sense of ownership by receiving shares in the company where they work. They begin to believe that they are owners rather than employees of the company. They also benefit from the company’s profits in the form of dividends, which motivates them to work hard for their success.
3. It allows businesses to pay without affecting their bottom line.
4. ESOPs are a great option for retirement planning because they are easy to transfer. Employees can own a stake in the company for as long as they want, and they can even sell their shares back to the company if they want to. Owners can incentivise payment and production by giving employees a piece of the business. Employee productivity rises, and the company’s culture improves as well. After that, the company can repurchase shares and continue to support employees even after they retire.

Disadvantages of Employee Stock Option Plan

1. The founders’ shareholdings are diluted when the ESOPs are exercised.
2. Since the company is not publicly traded, the shares of a private company have no marketability or liquidity. As a result, when an employee leaves the company, there is a risk of conflict between employers and employees.
3. There is also the possibility of disagreements over the value at which shares should be transferred during the transfer of shares.

Things to be taken care of by an employee while receiving ESOPs

• Appropriate Documentation

Employees should double-check that all paperwork is in order. They should also consider the current and future value of the stock.

• Proper Exit System

If the start-listing up’s is delayed, make sure there is a proper exit mechanism in place, such as promoter buyback.

• Taxation

Employee stock ownership plans (ESOPs) are taxed as part of the employee’s benefits. However, if you sell the shares, the difference between the sale price and the fair market value on the date of allotment will be subject to personal capital gains in the hands of employees.

Conclusion

An employee stock option plan is a type of compensation that employers offer to their employees. It has various benefits, and hence, ESOPs are a great way for start-ups to attract and retain talent, but they’re also a risky bet for employees. Employees should be convinced of the company’s growth, and proper documentation should be in place.