ESOPs: All you need to know about Employee Stock Options

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ESOP

ESOPs (Employee Stock Option Schemes) are programmes proposed with the basic interest of both, employers and employees. The company providing the scheme gives the employees an incentive in the form of ownership interest, while the employer is able to retain a high quality employee it would not otherwise be able to afford.

By providing stock options, either at a particular rate fixed by the company or through various schemes designed by the board of directors, ESOPs are issued for mutual benefits and are considered the most practical means of motivating and retaining an employee.

ESOPs are issued in the form of direct stock, bonuses or through profit-sharing plans, and only the employer has the right to decide who can avail of the options.

However, ESOPs are just options, which can be purchased at a certain price before a certain date or not. There are certain norms and rules set by the Company Rules Act, 2014 for granting of ESOPs to employees.

Essential terms in ESOP

While the broad definition of an ESOP may be clear, its finer details can be pretty hard to understand. Let’s go through them, one by one, to understand them better.

Grant: This is the process through which the employee is offered the share. Grant price and grant date are the price at which the shares are offered and the date on which it is made available. Before granting the shares, the company gives an option to the employee to either purchase it or leave the option.

Vesting period: The specific time the employee must wait to exercise the ESOP options is the vesting period. The employees can wait until the vesting period to convey to the employers their decision about buying the stocks (ESOP) offered. Once the vesting period is over, and if the employees decide to purchase the shares, they need to remit the exact amount demanded for the shares to purchase them.

Benefits of ESOP plans

Owner’s perspective: Although employee retention, motivation and awarding hard work are all the benefits that comes out of ESOP for an employer, there are various other notable advantages too, especially for startups.

With ESOP options, one can avoid cash compensations as a reward, thereby saving on the immediate outflow of cash. For startups especially, when they are on the verge of expanding, or beginning their operations on a larger scale, awarding employees in the form of stock options will work out to be a feasible method than cash rewards.

ESOPs are given as a motivation to the employees. Since the employees will be benefitted in turn, when the share prices increase, it will be an incentive enough for the workers to put in their 100%. Similarly, ESOPs can also help you attract the best talent in the market.

Employee’s perspective: Employees have the benefit of acquiring shares at a nominal rate, and also selling it (after a suitable tenure set by the employees) and gaining the profit. If, for instance, the share prices shoot up, as it is bound to happen when a company grows over the years, a good deal of profit is gained by selling the shares.

Certain companies set ESOPs as a separate entity other than the salary options, and hence, it adds on to the benefits you receive as an employer.

ESOPs are a part of an employee’s salary, and hence, are taxable income, exercised as per the rules.

Hence, ESOPs are both beneficial options to an employer as well as an employee. However, it is crucial to understand the terms and conditions pertaining to ESOPs and also to understand that granting ESOP itself does not signify enormous cash benefits. The share price on the say you sell them (after a cliff period) and also any other conditions, all needs to be checked before exercising the option or as for employers, before providing them to the workers.

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A lawyer with 14 years' experience, Vikram has worked with several well-known corporate law firms before joining Vakilsearch.

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