Features Employee Stock Option Plan (ESOP)

What is an Employee Stock Ownership Plan or Employee Stock Option Plan or ESOP?

Employee Stock Ownership Plans are abbreviated as ESOPs. They are a sort of employee compensation plan in which employees can accumulate equity in the firm over time.

Employees have the opportunity under the ESOP contract to convert their ESOPs to employees’ stocks at a predetermined rate over a certain length of time (vesting/option period).

It is vital to emphasize that ESOPs do not immediately grant employees stock ownership.

Working on Employee Stock Option Plan

The employer distributes certain equities from its trust fund to employees under an ESOP arrangement. Employees can now exercise their ESOPs after they have completed the predetermined vesting time. Employees must work for the company for the stipulated vesting term to execute their ESOPs. If an employee quits before the vesting term is completed, they will be unable to exercise the ESOP and convert it into company shares.

Who can get Employee Stock Option Plan or Employee Stock Ownership Plan?

• A firm’s regular staff who works in or outside of India.
• A company director, including a full-time or part-time director but not an independent director.
• A permanent employee or director of an Indian or foreign subsidiary firm, holding company, or associate company.

What are Employee Stock Option Plans Allotted?

Three periods are primarily concerned with the timing of issuing of shares to employees via ESOP. These are their names:

• Grant: The distribution of ESOP shares to employees. It entails telling the employee that he is qualified for an ESOP. While offering the ESOP option to employees, the corporation will be allowed to choose the exercise price.
• Vest: The right of employees to apply for the ESOP shares that have been issued to them. The ESOP system requires a minimum of one year between option award and option vesting.
• Employees can exercise their option to purchase shares throughout the exercise period. The corporation will be allowed to choose the lock-in period for the ESOP shares issued (if any) once the option is exercised. Employees will not be able to collect dividends, vote, or enjoy the benefits of a shareholder under the ESOP provided to them until the ESOP shares are issued upon exercise of his option.

ESOPs (Employee Stock Ownership Plans), along with other personalized perks such as employee health insurance and enhanced career advancement prospects, play an important role in recruiting and keeping top employees. ESOPs not only allow ESOP for private companies to sweeten the pot, especially if they can’t afford very large compensation packages straight away, but they also instil in employees a sense of ownership. Aside from the compensation, entrepreneurs have found ESOPs to employees to be an appealing motivator for joining a firm.

The three most critical considerations for any ESOP scheme are –

• The quantity of ESOP shares that an employee may purchase
• The price at which shares can be purchased
• The time after which the ESOP shares might be purchased

Example to understand ESOPs

Assume Khanna Pvt . ltd. provides the following ESOPs to employees:

• 100 ESOP shares @Rs.100
• Option/vesting period – 5 years

This implies that if the employee is still on Khanna Private Limited’s payroll after five years, they can acquire 100 shares at Rs.100 apiece, regardless of the market ESOP valuation of the company’s stock. Some small enterprises and ESOP startups enable vesting at a shorter interval: for example, 100 ESOP shares vest proportionally over five years: the employee obtains 20 ESOPs per year.

What are the Features of ESOPs?

• Employees receive ESOPs at no cost. They are a component of an employee’s CTC (Cost to Company).
• The vesting date is the day when an employee may execute their ESOP and transform it into company shares. On the other hand, the grant period is the date on which the ESOP is granted as a result of a formal agreement between the firm and the employee.
• ESOPs can be offered to certain employees or all employees, depending on the employer’s recruitment strategy.
• In some cases, ESOPs can be exercised in instalments over a set length of time.
• The ESOP valuation of an option, also known as the grant price, is the price at which employees can buy a company’s stock through ESOPs.
• Employees are not obligated to participate in their ESOPs.

What are the ESOPs benefits for employees?

Although ESOPs are included in an employee’s CTC, they benefit both businesses and employees.

ESOPs might be the deciding factor in talent acquisition for firms. Here’s how it’s done:

1. Acquiring top talent: When funds are scarce in the early years of a firm, ESOPs try to fill the void by paying employees. Employees that believe in the company’s development potential accept ESOPs as part of their remuneration package to purchase the company’s shares at a lower cost. This aids in the acquisition of strong personnel at a lower initial cost.
2. Increase employee ownership: Employees are self-motivated to put forth their best efforts for optimal productivity when they have a part in the company’s ownership. After all, the higher the profitability, the higher the stock ESOP valuation of the firm and the larger the earnings that employees may make.
3. Employee retention: Employee stock ownership plans (ESOPs) aid employee retention. Employees choose to stay with the firm to cash in their stock options after the vesting period because they can only do so after the vesting period. This improves retention while also lowering attrition rates, which may be frighteningly high in the technology industry.

ESOPs Benefits

Employees gain from ESOPs for the following reasons:

• Increased earnings at lower rates: They assist employees in acquiring attractive stocks at a lower cost. Employees can then keep these equities for long-term gains or sell them at a greater market ESOP valuation to profit from their stock holdings.

• Additional Source of Income: Employees who become shareholders have voting rights in the company’s management. They also receive a dividend on their shares, which provides extra income.

• Job Security: Employees benefit from employment stability due to the vesting term, which increases employee happiness.

Taxability of ESOPs

– There are no tax consequences to allocating ESOPs to employees potential employees. 

– If the employee makes a profit after selling the shares, it is termed capital gains. Shares are sold within a year, a 15% capital gains tax must be paid, just like any other stock purchase or sale.

– If the capital gains are long-term (lasting more than a year), a 10% tax must be paid without indexation advantage or a 20% tax must be paid with indexation benefit.

What do employers need to know before opting for ESOPs?

Though ESOPs can assist firms in attracting top personnel, particularly in a cash-strapped economy, there are several factors to consider before issuing them to employees.

To begin, certain legal norms and regulations regulate the operation of 

The future of ESOPs startup environment

ESOP Startups have special challenges in raising adequate financing during their early stages. As a result, ESOPs have proven to be the optimal remuneration system for attracting and keeping top individuals.

Over to you!!

Since January 2020, companies have provided $700 million in ESOPs, proving that ESOPs are here to stay. However, employers must recognize that providing attractive perks isn’t the only way to keep employees happy and satisfied.

Read Also: Stop Sexual Harassment in the Workplace With POSH Act.

FAQs

Is an ESOP advantageous to employees?

Employee stock ownership plans (ESOPs) are a popular type of employee compensation. It aids in a firm’s liquidity and serves as an incentive for staff loyalty. Aside from the in-hand income, ESOP startups have found ESOPs to employees to be an appealing inducement for joining a firm. Employee stock ownership plans (ESOPs) foster a sense of ownership in employees, especially when they cannot afford large salary packages.

Who is considered a permanent employee for the ESOP issue?

The legal regulations of an ESOP do not define the phrase “Permanent Employee,” nor does it appear in the Companies Act. In terms of practicality, an employee who has completed the probation period can be regarded as a permanent employee in both detailed and unlisted organizations.

Can future employees be included in the ESOP scheme?

Yes, the ESOP plan can include current and future firm workers, i.e. employees who join after the program’s approval.

Can the ESOP exercise price be less than the face value?

No, a corporation can set the exercise price lower than the current market price or at a discount, but it cannot be lower than the face value of the shares.

Could the value of an option for each worker fluctuate for the same exercise date?

Yes. On a discretionary basis, the grants may be awarded to each employee or class of workers at a different exercise price.