What is Employee Stock Option Plan | Planify

An ESOP (Employee stock ownership plan) refers to an employee benefit plan which offers employees an ownership interest in the organization. Employee stock ownership plans are issued as direct stock, profit-sharing plans or bonuses, and the employer has the sole discretion in deciding who could avail of these options. However, Employee stock ownership plans are just options that could be purchased at a specified price before the exercise date. There are defined rules and regulations laid out in the Companies Rules which employers need to follow for granting of Employee stock ownership plans to their employees.

ESOPs help companies to reduce their operational expenses. Companies give less salary to their employees but compensate the same through ESOP shares. This will help start-ups to acquire talent at a lower cost.

For example, let us suppose the package of the employee in the company is 10 lakhs per annum. The company may give 8 lakhs as cash and rest 2 lakh in the form of ESOPs i.e. shares of the company.

ESOPs have a certain time frame before which they can be exercised. It means employees have to work in the company for a certain period to get eligible for buying shares of the company. Generally, ESOP shares are given in tranches of 25% every year and 100% gets completed in 4 years. As ESOP shares are issued in tranches, the attrition rate (the speed at which employees are leaving the organization) gets reduced considerably. Employees think that if they leave early, they will not get the benefit from ESOPs shares. So they work longer in the company.

Advantage of ESOPs for Employees?

ESOPs can be a game-changer for the employees. If an employee is having ESOP shares of a company that has become Unicorn-name given to the startup having valuation above $1 Billion dollars, then the value of those ESOP shares will make employees super-rich.

We have seen this in the case of Flipkart India, when it was purchased by Walmart at a whopping valuation of 1.16 lakh Crores in the year 2017-18. Flipkart India had given ESOP shares even to the drivers of the company. So in that deal, everyone got a big chunk of return on ESOP shares and after that deal, many became millionaires.

Similarly, Paytm has issued ESOP shares to its employees at Rs.90 per share and in the unlisted market, it was sold in the price range of 5k to 18k. So we can calculate the kind of return they have generated. Obviously, the number of shares given to employees under ESOP scheme depends upon a position in the company but even then the small number of ESOP shares can make an employee rich once the company’s valuation touches the unicorn status.

The problem for Employees?

Liquidation is the biggest problem for the employees who are having ESOPs of the startups. Let us suppose the employee has ESOP shares in his/her demat account. And he/she wants to sell ESOP shares to get some immediate funds. So what is the solution?

They can approach the company requesting to buyback those ESOP shares. This option is not viable most of the time.

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How does esop work in india ?

Employee stock option is a profitable plan which is created in favour of employees in order to benefit them with maximum returns. In this plan, an employee enjoys the right to acquire the company’s share.

Other Type of Incentives -

ESPP (Employee Stock Purchase Plan):

In this scheme, after a certain tenure/period of time, the company, offers its shares to its employees at a discounted price which is generally 10-15% less than the market price.

Stock Appreciation Rights:

In this scheme, the company offers its employees a compensation of an amount equal to the appreciation value of the share in a predetermined time

RSU (Restricted Stock Units):

In this scheme, the company offers its shares to their employee on the basis of their compensation letter but along with some restrictions and limits

Phantom Shares – Phantom stock is a form of long-term deferred compensation using the Company shares as the measuring device for calculating the value of the deferred compensation. It simulates the Company shares in everything except that does not represent true ownership.                  

RSA - Restricted Stock Award

 

 

Few Terminologies related to ESOP:

 

●      Grant an option: This is an option where a company offers a right to its employee to buy the company’s shares.

●      Grant Date: It is a date on which the employee receives the ESOP option

 

●      Vesting Date:  It is a date on which the employee becomes entitled to exercise the options

 

●      Vesting Period: The period between vesting date and Grant date.

 

●      Exercise: Initially, the company offers a grant an option to its employees where an employee is free to convert its option into shares. This is known as Exercising the option

 

 

●      Exercise price: This is the price at which the shares are offered to its employees. This price is usually less than the current market price. It is also known as Strike price.

 

●      Exercise Period: This is the period where an employee gets a chance to exercise its share. This is known as Exercise period

 

●      Fair Market Value: The market value of shares during its allotment period is known as Fair market value.

 

How can we calculate the tax on ESOPs?

There are two stages of tax calculation on the shares allotted as ESOPs:

1^st Stage- When an employee exercises their options after the vesting period

2^nd Stage- When the employees sell their allotted shares

 

 

Tax Implication after the option is exercised:

 

When the options are exercised under the ESOPs, then the tax is levied on the perquisite value (Perquisite value= FMV-Exercise Price).

If the shares get listed in India, then the value of the allotted shares are calculated on the basis of average price (average of highest and lowest price). If the shares are unlisted then FMV is calculated on the basis of the valuation certificate issued by the merchant banker and the valuation certificate should not be more than 180 days of the exercise date.

Even if the company is listed outside India, it has to take the valuation certificate from the merchant bank because the shares listed in abroad are treated as unlisted share for the ESOP purpose. 

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