What is an Employee Stock Option Plan (ESOP)?
When a company gives an employee the option to buy stocks of the company in the future, but at a pre-determined price, it is termed an ESOP. It is an option given to employees of the company, defined under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
Advantages for the Company
Granting ESOPs is a way to motivate employees to stay for a longer period of time. It maximises wealth creation, along with building trust in the company's resources, and also increases the company's cash flow.
Advantages for the Employees
For employees, an ESOP is an addition to their salary, a share in equity growth. If an employee opts into this, they also become eligible for the company's profits in the form of dividends.
Disadvantages for Employees and Company
An ESOP is a policy that may have certain terms and conditions. Therefore, one must be careful to do a background check of the fundamentals of the company before deciding on the option. Tax implications are also to be looked into, from both the company and the employee's point of view.
ESOP Policy
This policy can be formulated at any stage by the company. Companies have the freedom to determine the exercise price, and ESOPs can be given out in the form of grant letters.
Things to Know Before Signing Up for ESOPs
- Value of ESOPs: the value of ESOPs is determined based on the time/point at which the ESOPs are granted.
- Cliff: the minimum time period an employee has to complete for the company to provide the option of an ESOP.
- Exercise period: employees have the option to buy the company's stock and convert this option into stock within a said time period. This time period is called the exercise period.
- Vesting period: vesting is the length of time an employee must wait in order to be able to exercise their ESOPs. Employees get ESOPs over a vesting period, i.e. over a period of time.
Conclusion
ESOPs are a great option for start-ups to attract a greater number of employees. But continuing in the same company for a longer time span is what is expected. Being a good way of retaining employees, ESOPs also come with some challenges for the company.
Disclaimer: The content of this article is intended to provide general guidance on the subject matter. Specialist advice should be sought about your specific circumstances.