The Employee Stock Option Plan Scheme is one of the best schemes ever designed for employee benefits. Read on to find out the key features.
Overview:
ESOP, or the Employee Stock Option Plan, is a strategic employee benefits scheme. This Employee Stock Option Plan Scheme is offered by the company to its employees to promote employee ownership in the company. Employees receive discounted shares of the companies. Any type of company can issue an employee stock option scheme. All companies, except the listed companies, need to issue this scheme as stated in the provisions of the Companies (Share Capital and Debentures) Rules of 2014 and the Companies Act of 2013. The listed companies need to issue the scheme following the employee stock option scheme guidelines issued by the Securities and Exchange Board of India.
According to Section 2(37) of the Companies Act, 2013, employees’ stock option plans give the employees, officers, and directors of the company or of its subsidiary or holding company the authority to buy, subscribe or benefit from the company’s shares in the future. In simple words, an Employee Stock Option Plan is a policy where a company offers to grow its subscribed share capital by offering company shares to its employees at a set price.
The Employee Stock Option Plan not only benefits the company but the employees as well. It helps startups or growing companies where employees can be remunerated after the company becomes bigger. Any employee can be offered an employee stock option plan by their company, but only if they succeed in meeting the necessary conditions. Every type of company, both big or small, startups or blue-chip ones, can offer employee stock option plans. They help in developing succession plans by offering opportunities to buy stocks in the company.
How ESOP Scheme Works:
Shares:
ESOPs operate by allocating ownership shares to employees, providing them with a tangible stake in the company’s success. This distribution of shares fosters a sense of ownership among employees, aligning their interests with the overall goals of the organisation.
Vesting:
The concept of vesting plays a crucial role in ESOPs. Employees earn ownership of allocated shares over a specified period, known as the vesting period. This encourages employee commitment and dedication, as ownership is earned over time.
Eligibility:
To participate in an ESOP, employees typically need to meet certain eligibility criteria. This may include factors such as tenure, job classification, and full-time employment status.
Contributions:
Both employees and employers play a role in contributing to the ESOP. Employees may contribute a portion of their salary, while employers contribute shares or cash to fund the program.
Valuation:
The valuation of ESOP shares is a critical aspect, influencing the allocation of benefits to employees. Various methods, including market value and book value, are employed to determine the worth of the shares
Diversification:
ESOPs often provide mechanisms for employees to diversify their investment portfolios. This allows employees to manage their ESOP holdings and reduce risk.
Exit Strategy:
Employees may exit the ESOP for various reasons, such as retirement or resignation. Understanding the exit strategy ensures a smooth transition and fair treatment of employees.
Tax Advantages:
ESOPs offer tax benefits for both employees and employers. These advantages contribute to the overall appeal of the scheme, making it a financially attractive option.
Employee Benefits:
Participating employees enjoy various benefits, including potential financial gains and a heightened sense of involvement and responsibility within the organisation.
Employers’ Role:
Employers play a crucial role in administering and managing the ESOP scheme. Clear communication and effective management are essential to ensure the success of the program.
Advantages of ESOP Scheme:
Tax Benefits:
ESOPs come with significant tax advantages. For employees, capital gains tax may be deferred, and for employers, contributions to the ESOP are often tax-deductible.
Employee Motivation:
ESOPs serve as powerful motivators for employees. The opportunity to become a shareholder creates a sense of pride and commitment, leading to increased dedication and performance.
Retention of Top Talent:
By providing employees with a stake in the company, ESOPs contribute to the retention of top talent. The sense of ownership fosters loyalty and commitment.
Wealth Creation:
ESOPs enable employees to accumulate wealth over time. As the company prospers, so do the employees who hold shares, creating a mutually beneficial relationship.
Retirement Savings:
ESOPs can serve as an effective retirement savings mechanism. Employees can build a financial cushion for their retirement years through the appreciation of ESOP shares.
Increased Employee Engagement:
The sense of ownership and responsibility associated with ESOPs leads to increased employee engagement. Engaged employees are more likely to contribute positively to the company’s success.
Alignment of Interests:
ESOPs align the interests of employees with the long-term success of the company. When employees have a direct stake in the organisation’s performance, their goals become closely intertwined with those of the company.
Succession Planning:
ESOPs contribute to effective succession planning. By ensuring a pool of committed and capable employees, companies can transition smoothly during leadership changes.
Positive Company Culture:
The implementation of ESOPs fosters a positive and collaborative company culture. Employees feel valued and connected, creating a workplace environment that encourages innovation and teamwork.
Competitive Advantage:
Companies with ESOPs gain a competitive edge in attracting and retaining talent. The prospect of ownership enhances the company’s appeal, especially in competitive job markets.
ESOP Contributions in Financing Debt:
ESOPs can be strategically utilised to contribute to the company’s financial structure and debt management. By providing a means for employees to acquire ownership, companies can strengthen their financial position.
ESOP Eligibility:
Director, Company, Promoters, Equity:
Eligibility criteria may include the role of directors, the nature of the company, the involvement of promoters, and the distribution of equity among employees.
Full-Time Employment, Tenure, Age Requirement:
Factors such as full-time employment, tenure, and age requirements may determine an employee’s eligibility to participate in the ESOP.
Job Classification, Citizenship or Residency:
Eligibility criteria may be influenced by job classification and considerations related to citizenship or residency.
Active Employment, Employment Status:
Active employment and employment status are crucial factors in determining eligibility for the ESOP.
Company Size:
The size of the company can impact eligibility criteria. Larger companies may have different criteria compared to smaller enterprises.
Key Features of Employee Stock Option Plan
The key features of employee stock option scheme include:
- Specifying objectives such as employee motivation or reward for performance, retention, and so on.
- The approved modes of payment include stock shares, cash, or a combination of the two of these.
- When it comes to equity shares, whether secondary or primary, the streams of the shares are essential.
- Strategy for execution: directly by the company or through a trusted party.
- The process for Identifying the manager/administrator is as follows:
- The manager/administrator plays the role of the scheme’s main decision-making forum.
- The maximum and minimum vesting length of time, along with the criteria and schedule of vesting, are all fundamental parts of the vesting parameters.
- The exercise/strike price that employees need to pay, as well as the duration in which employee stock option plans need to be exercised, are examples of exercise criteria.
- Other significant themes are clarification of employee stock option rights, ESOP taxes, a course of steps in the matter of a corporate action like a rights issue, merger, bonus issue, or outside corporate action, jurisdiction, and data privacy protection.
Why Should You Go for an Employee Stock Option Plan Scheme?
Here are some of the points that might help you to understand the benefits that you can achieve by going for an employee stock option scheme.
- A ready market for the company owner’s shares: an employee stock option plan allows the company owner to develop a ready market for their stocks among directors and employees.
- Owners of the Employee Stock Option Plan Scheme can borrow money at a very low after-tax rate of interest.
- The ESOP also comes with other tax benefits, like:
- In an Employee Stock Option Plan scheme, new shares can be issued at a current cash flow advantage as stock contributions are deductible.
- Cash contributions are also tax-deductible, which allows the company to make yearly payments to the employee stock option scheme and obtain a tax credit to build up emergency funds for future use.
- The Employee Stock Option Plan works as a retention mechanism, which is important for startup businesses or small companies. This is because, due to the plan, employees might be able to use their privilege to buy stocks during a lock-in period. If employees choose this scheme, they might be obligated to stay in the company for the entire lock-in period and won’t be able to quit their position in the company during this time. This allows the company to retain its best talents within the company.
- An ESOP (Employee Stock Option Plan) implants a sense of proprietorship among the employees. The employees feel like they are not just ordinary employees but also an important part of the company. Having a share in earnings motivates and encourages employees to achieve the organisation’s goals (through dividends).
- The ESOP’s non-monetary incentives help the company or firm to compete for high-performing employees.
- An ESOP also allows company owners to gain liquidity without selling the company to a third party or a competitor.
How Does ESOP Work?
A company offers ESOPs to its employees for purchasing a stipulated number of stocks at a low cost. The employee can sell the stocks after a given period (a specific number of years). This option period is known as the vesting period. Before an employee can take advantage of his benefits, they need to undergo a pre-determined vesting period. In simple words, the employee has to stay ain in the company until she or he can take advantage of the share option given to her or him.To develop an employee stock ownership plan, a company has to build trust first. Such contributions by the company are tax-deductible but up to certain limits. Next, the company might issue these stocks to the accounts of their employees. The allocation is usually done based on the years of service that the employees have given to the company or in proportion to compensation. The employer might even consider both of these criteria when computing the allocation percentage. New employees can generally avail themselves of the advantages of the employee stock option scheme and start gaining allocation after providing a year of service.
What Are the Benefits of an ESOP for Employees?
The following are the ESOP benefits for employees:
- Employees receive the advantage of gaining company shares at a considerable price.
- Employees might make a huge profit after the vesting period or by selling the ESOPs.
- Employees can enjoy a portion of the profits gained by the company.
- They don’t have to pay any upfront charges.
Conclusion
ESOP, or employee stock option scheme, allows employees to own a share of the company at a very low cost. To take advantage of this scheme, an employee needs to remain in the company for the entire vesting period. This scheme allows employees to be profitable. However, an employee needs to know all the key features of an Employee Stock Option Plan scheme before opting for it. With the expertise of our talented pool of legal experts at Vakilsearch, we can help you register and provide ESOP plans for your employees in the right way!
FAQs
What is an Employee Stock Option Plan (ESOP) scheme?
An Employee Stock Option Plan (ESOP) scheme is a benefit program offered by companies to their employees, allowing them to purchase company stock at a predetermined price within a specified period.
Are there different types of ESOPs?
Yes, there are various types of ESOPs, including non-qualified stock options (NQSOs) and incentive stock options (ISOs), each with different tax implications and eligibility criteria.
What are the tax implications of ESOPs?
The tax implications of ESOPs depend on factors such as the type of options, timing of exercise, and subsequent sale of shares. Generally, employees are subject to taxes on the difference between the exercise price and the fair market value of the stock at the time of exercise.
What are the vesting schedules for ESOPs?
Vesting schedules determine when employees gain ownership of their ESOP shares. These schedules can vary, but commonly, shares vest over a specified period, typically ranging from three to five years, to incentivize long-term employment.
Can employees sell their ESOP shares?
Employees can typically sell their ESOP shares after they have vested and met any additional conditions specified in the ESOP agreement, such as a holding period or compliance with insider trading regulations
What are the risks associated with ESOPs?
ESOPs carry certain risks, including the potential for a decline in the company's stock value, which could result in a decrease in the value of employees' shares. Additionally, employees may face tax consequences if they exercise options but are unable to sell the shares at a profit.
Also, Read
- What Is an Employee Stock Option Plan?
- What Is the Issue of Shares Through ESOP?
- What Are the Different Types of ESOPs in India?
