What is an Employee Stock Option Plan (“ESOP”)?
When company gives an employee the option to buy stocks of the company in the future, but at a pre-determined price, it is termed as ESOPs. It is an option given to the employees of the company defined under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
Advantages for the company:
Granting ESOPs are a way to motivate employees into staying for a longer period of time. It maximizes wealth creation along with gaining trust in their resources. It also increases the cash flow of the company.
Advantages for the employees:
For employees, ESOPs is an addition to their salary, it is a share in equity growth. If an employee opts for this option, they are also eligible for the profits of the company in the form of dividends.
Disadvantages for employees and company:
ESOP is a policy that may have certain terms and conditions. Therefore, one must be careful while doing 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 employee’s point of view.
This policy can be formulated at any stage by the company. Companies have the freedom to determine the exercise price. 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 are determined basis the time/ point at which the ESOPs are granted.
- Cliff: It is a minimum time period an employee has to complete for the company to provide the option of an ESOP.
- Exercise period: Employees have an option for buying company’s stock and converting this option into a stock within a said time period. This time period within which the option has to be availed is called exercise period.
- Vesting period: Vesting is the length of time that an employee must wait in order to be able exercise their ESOPs. Employees get ESOPs over a vesting period i.e., over a period of time.
ESOPs are a great option for start-ups to attract more 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, it also comes with some challenges for the company.
The content of this article is intended to provide general guidance on the subject matter. Specialist advice should be sought about your specific circumstances.