What is ESOP in Salary

To understand how ESOPs work, it helps to know a few key terms:

• ESOP (Employee Stock Option Plan): Gives you the right to buy shares at a fixed price, usually lower than the market price.
• ESPP (Employee Stock Purchase Plan): Lets you buy shares using money from your salary, usually at a discount.
• RSU (Restricted Stock Unit): Company promises to give you shares in the future once certain conditions are met.
• Grant date: When your company offers you the stock options.
• Vesting date: When you become eligible to buy the shares.
• Vesting period: The time you must stay with the company before you can own the shares.
• Exercise period: The time frame in which you can buy the shares after vesting.
• Exercise date: When you actually buy the shares.
• Exercise price: The price you will pay to buy each share.
• FMV (Fair Market Value): The current value of the company’s shares.

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Let us take a closer look at the financial side of ESOPs:

• Grant price: This is the price set when your ESOPs are offered, usually lower than market value.
• Vesting period: The waiting time before you can buy your shares.
• Exercise price: The fixed cost you’ll pay per share when buying your ESOPs.
• Fair market value: The market value of the shares at the time of buying.
• Taxation: ESOPs are taxed at two stages, first, when you buy the shares (exercise), and second, when you sell them.

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Companies offer ESOPs to reward performance and encourage loyalty. Here is why they matter:

• Attracting talent: In competitive markets, ESOPs help companies attract skilled professionals by offering a stake in future profits.
• Retaining employees: The vesting period keeps employees invested in the company long-term.
• Alignment of goals: When you own part of the company, your goals align with its growth.
• Non-cash compensation: ESOPs let companies offer a strong benefit without raising salary costs immediately.
• Performance rewards: ESOPs are often tied to your performance or the company’s success, making them a motivational tool.

Read more: When are ESOPs very effective

For employees, ESOPs are more than just an extra benefit. Here is how they help:

• Ownership: They give you a real stake in the company.
• Potential financial gain: If your company grows, the value of your shares grows too.
• Long-term benefit: They are an investment for your future, often maturing after a few years.
• Tax benefits: In some cases, ESOPs enjoy favourable tax treatment when compared to bonuses.

Companies also see several advantages when offering ESOPs:

• Motivation: Employees work harder when they have a personal stake.
• Retention: With a vesting period, employees are more likely to stay longer.
• Tax savings: Companies can claim deductions for ESOP-related costs.
• Culture building: Employees feel more connected and committed when they are owners too.

Here is how the ESOP journey usually looks:

1. Granting: You receive stock options as part of your salary package.
2. Vesting: You earn the right to use the options over time.
3. Exercising: After the vesting period, you can buy the shares at a fixed price.
4. Selling: You can sell your shares later to make a profit usually during a liquidity event or after the company is listed.

Let us understand how taxes work with ESOPs using an example.

Scenario: Priya receives ESOPs to buy 2,000 shares at Rs. 50 each. When she exercises her options, the market value is Rs. 120.

Taxable amount = (Rs. 120 – Rs. 50) × 2,000 = Rs. 1,40,000
This Rs. 1,40,000 is added to her income and taxed as per her tax slab.

If she sells her shares later:

• Short-term gains (held for under 1 year) are taxed at 15%.
• Long-term gains (held for over 1 year) are taxed at 10% beyond Rs. 1,00,000 of profit.

Here is a quick comparison of capital gains tax rates based on asset type and holding period.

Let us revisit Priya’s example:

• On 1st Oct 2024, she sells 1,000 shares at Rs. 150 each.
  Profit = Rs. 30,000 - Tax @15% = Rs. 4,500 (Short-term capital gain)
• On 1st May 2025, she sells the remaining 1,000 shares at Rs. 180.
  Profit = Rs. 60,000 - Tax @10% = Rs. 6,000 (Long-term capital gain)

If her total long-term capital gains in the year are under Rs. 1,00,000, she may not have to pay tax on them.

When your company lists on a stock exchange, your ESOP shares become tradeable and their FMV is set by the market. Before listing, the FMV of unlisted ESOP shares is generally determined by a merchant banker using recognised valuation methods. Since the shares are not publicly traded, liquidity is limited, and employees may find it difficult to sell them. ESOP financing can help bridge the exercise-cost gap if you need funds to exercise vested options before listing.

After listing, the share price is determined by market demand and supply. Once applicable lock-in periods and trading restrictions end, you may be able to sell your ESOP shares on the open market, subject to company policies and regulatory requirements.

While Employee Stock Ownership Plans (ESOPs) can be rewarding, they also come with risks that employees should clearly understand before accepting them. The value and benefits of ESOPs depend heavily on company performance, policies, and future outcomes. Key risks and considerations include:

• Uncertain value of shares: ESOP value is not guaranteed. Market conditions, business performance, or funding challenges can significantly impact the eventual share price.
• Vesting conditions and timelines: ESOPs vest over time. Leaving the company early may lead to partial or complete forfeiture of unvested options.
• Liquidity constraints: In unlisted companies, selling shares may not be easy. Liquidity often depends on IPOs, buybacks, or secondary sales.
• Exercise cost burden: Employees may need to pay an exercise price to convert options into shares, which can be a financial strain without assured returns.
• Tax implications: ESOPs are taxed at multiple stages—on exercise and on sale which can reduce overall gains if not planned properly.
• Dilution risk: Future ESOP grants or fundraising rounds can dilute existing shareholding, lowering the percentage ownership.

Understanding these factors helps employees make informed decisions and assess whether ESOPs truly align with their financial goals and risk appetite.

How do ESOPs affect employee salary and benefits?

ESOPs increase your total compensation package without raising your monthly take-home salary — their value depends on vesting and company performance. These ESOP salary benefits can increase your long-term wealth potential, but they are not paid as regular cash income.

For example, a ₹12 lakh annual salary with ESOPs worth ₹3 lakh in grant value represents a ₹15 lakh CTC, even if the monthly take-home salary remains unchanged. If you need funds to exercise vested options, explore ESOP financing options from Bajaj Finance.

Now that you know what ESOP is and how it fits into your salary, you can make smarter decisions about your financial future. ESOPs give employees more than just financial gain, they give you ownership, purpose, and alignment with your company’s goals. For employers, they are a win-win tool for building loyalty, attracting talent, and encouraging performance.

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