Why do companies offer ESOPs?
Companies offer ESOPs as a long-term strategy to attract, motivate, and retain talent while aligning employee interests with business growth. When employees own a stake in the company, they are more likely to think like owners, not just employees. Key reasons companies introduce ESOPs include:
Talent attraction and retention: ESOPs help companies compete for skilled professionals without immediately increasing fixed salaries.
Employee motivation: Ownership creates a stronger sense of responsibility and commitment towards company performance.
Alignment with long-term goals: Employees benefit when the company grows, encouraging sustainable decision-making.
Cash flow efficiency: ESOPs reduce immediate cash outflow compared to high salaries or bonuses.
Building ownership culture: Encourages loyalty and reduces attrition, especially in startups and growth-stage firms.
ESOP initial costs and distributions
While ESOPs are attractive, they involve specific costs and structured distribution mechanisms that companies and employees should clearly understand from the start.
Initial costs associated with ESOPs:
Legal and compliance costs: Drafting ESOP schemes, shareholder approvals, and regulatory filings involve upfront expenses.
Valuation costs: Companies must periodically value shares to determine fair pricing for ESOP grants and exercises.
Administrative expenses: Managing vesting schedules, employee records, and reporting requires ongoing effort.
How ESOP distributions typically work:
Vesting-based allocation: Shares are distributed gradually over time, based on predefined vesting schedules.
Exercise on eligibility: Employees can purchase vested shares at the exercise price set by the company.
Liquidity events: Actual monetary benefit usually arises during buybacks, acquisitions, or IPOs.
Tax implications: Distributions may attract tax at exercise and sale stages, depending on applicable rules.
Benefits of ESOP for employees
ESOPs go far beyond monetary rewards they create a sense of ownership that drives long-term engagement. Some of the key benefits include:
- Financial rewards: Employees gain ownership stakes, building long-term wealth.
- Motivation: ESOPs align employee efforts with organisational growth.
- Job satisfaction: Ownership fosters a sense of belonging and purpose.
- Retirement planning: ESOPs create a financial safety net for employees.
- Long-term commitment: Vesting schedules encourage employees to stay longer.
- Skill enhancement: Employees feel motivated to improve their performance.
- Wealth creation: Share price appreciation benefits employees financially.
Benefits of ESOPs for employers
ESOPs are not just employee-friendly tools; they offer several strategic advantages to employers as well. By offering ownership-linked rewards, companies can build a committed workforce while managing costs more efficiently. Key benefits of ESOPs for employers include:
Improved talent retention: Vesting schedules encourage employees to stay longer, reducing hiring and replacement costs.
Higher employee productivity: Ownership mindset drives employees to perform better and contribute to business growth.
Lower cash compensation burden: ESOPs help optimise salary structures by replacing part of cash payouts with equity.
Stronger alignment of interests: Employees work towards long-term company success rather than short-term targets.
Attractive employer branding: ESOPs enhance the company’s image, especially among skilled professionals and startups.
Succession and continuity support: ESOPs can aid ownership transition while maintaining management stability.
Overall, ESOPs help employers create a motivated, loyal, and performance-driven organisation without putting immediate pressure on cash flows.
How ESOPs work in the share market?
The ESOP in share market works through a structured process. Here is how:
- Granting options: Companies offer stock options to eligible employees based on role, performance, or tenure.
- Vesting period: Employees must stay for a certain duration before they can claim ownership rights.
- Exercise stage: Once vested, employees can buy shares at the exercise price (usually lower than the market value).
- Liquidity event: After exercising, employees can sell their shares during buybacks, IPOs, or other permitted events.
This process helps employees participate in wealth creation while maintaining company stability. It’s a system that motivates performance while offering tangible financial rewards.
ESOP valuation methods
Valuation is a crucial step in any ESOP. It determines how much each share is worth and ensures fair allocation. Common valuation methods include:
| Valuation Method |
Description |
| Fair Market Value (FMV) |
Determines share value based on market trends and company performance. |
| Discounted Cash Flow |
Calculates future cash flows, discounted to present value, to determine share worth. |
| Market Comparables |
Uses valuation metrics from similar companies in the same industry. |
| Net Asset Value (NAV) |
Assesses the company’s total assets minus liabilities to calculate share value. |
| Black-Scholes Model |
A statistical approach to evaluate options by considering volatility and time. |
Valuation ensures employees receive shares at a fair and transparent price maintaining trust and credibility in the ESOP system.
Tax implications of ESOPs in India
ESOPs (Employee Stock Ownership Plans) have become increasingly prevalent in the Indian share market, driven by several key trends:
Talent acquisition and retention:
- ESOPs have emerged as a powerful tool for attracting and retaining top talent, particularly in high-growth sectors like technology, fintech, and e-commerce.
- By offering a stake in the company's success, companies can motivate employees and foster a strong sense of ownership.
Increased competition for top talent:
- In a competitive job market, companies are constantly seeking innovative ways to differentiate themselves.
- ESOPs provide a unique value proposition for employees, making them a valuable tool in the talent acquisition war.
Startup growth and funding:
- The rise of startups in India has significantly boosted the adoption of ESOPs.
- Many startups use ESOPs as a key component of their employee compensation strategy, aligning employee incentives with company growth and attracting early-stage talent.
Shift towards long-term growth:
- ESOPs encourage employees to think long-term and contribute to the sustained success of the company.
- By aligning employee interests with shareholder value, companies can foster a culture of long-term growth and sustainability.
Government initiatives:
- The Indian government has been supportive of ESOPs, recognizing their potential to boost employee ownership and promote entrepreneurship.
- Various government initiatives have aimed to simplify the process of implementing and managing ESOPs.
Popular Companies Offering ESOPs:
- Technology giants: Google, Microsoft, Amazon, Meta, Apple
- Fintech startups: Paytm, Razorpay, CRED, PhonePe
- E-commerce companies: Flipkart, Amazon India, Meesho
- Edtech platforms: Byju's, Unacademy, Vedantu
What happens to ESOPs when the company is listed?
When a company gets listed through an IPO, ESOPs usually become more valuable and liquid. Listing brings market visibility, transparent pricing, and clearer exit options for employees holding stock options. Here is what typically happens to ESOPs after listing:
Conversion into listed shares: Exercised ESOPs turn into publicly traded equity shares.
Market-linked valuation: Share value is determined by stock market prices, not internal valuations.
Lock-in periods may apply: Employees may face temporary restrictions on selling shares post-IPO.
Easier liquidity: Once lock-in ends, employees can sell shares through stock exchanges.
Clear tax treatment: Tax applies at exercise (perquisite tax) and again at sale (capital gains).
Policy-specific rules: Final outcomes depend on the company’s ESOP scheme and IPO disclosures.
Conclusion
ESOPs have evolved into a cornerstone of modern workforce management, connecting personal achievement with company growth. They build trust, reward contribution, and promote wealth creation turning employees into long-term partners in success. In the share market, ESOPs also play a larger role by enhancing liquidity and broadening ownership. Whether you are an employee planning to exercise your options or a company structuring an ESOP, understanding how they work is key to maximising value.
Turn your stock options into real ownership today. Apply for ESOP financing and take your first step towards becoming a shareholder in your company.
