Employee Stock Ownership Plan (ESOP)

In today’s day and age, the way employees get compensated has changed. Businesses now attract and retain talent by offering ESOPs. These plans also make employees stakeholders in the company, thereby ensuring they have a vested interest in seeing the company grow and thrive.

So, what are ESOPs, and how do they work? Let’s understand this in detail.

Key takeaways

• The full form of ‘ESOP’ is the Employee Stock Ownership Plan.
• Companies offer ESOPs to employees as a form of incentive to remain with the organisation and work towards growth and mutual success.
• This employee benefit plan provides employees ownership interest in the organisation in the form of shares of stock.
• ESOPs also make employees feel more wanted and appreciated and are intended to compensate them for their hard work.
• Subject to specific conditions, these plans give employees the right to purchase shares in the business at a pre-determined price.

ESOP’s full form is the Employee Stock Ownership Plan, an employee benefit plan aimed to compensate workers beyond their basic wage packages and give them an ownership interest in the organisation. ESOPs are typically issued as direct stock, profit-sharing plans, or bonuses, while the employer is solely responsible for deciding who can avail of these options.

After knowing what ESOP is, you must also learn how it works, the costs involved, and how ESOPs are taxed in the country.

Primarily employed by start-ups to attract and retain talent, ESOPs instil a sense of ownership and loyalty among the employees. The Employee Stock Ownership Plan gives employees the right to buy company shares at a pre-set price prior to the exercise date, opening a path to ownership under certain conditions.

That said, before issuing ESOPs, employers must follow specific steps and adhere to compliance requirements as outlined under the Companies Act of 2013.

Employers can choose the number of shares they would like to offer under ESOPs, along with their price and the employees who will receive ESOPs. Afterwards, they are granted to the chosen employees, and a grant date is provided. After this, ESOPs remain in a trust fund for a certain period, which is called the vesting period. The caveat here is that the employees who are granted ESOPs must stay with the company for the vesting period to avail of the stock ownership by exercising the ESOP.

After the expiration of the vesting period (called the vesting date), employees have the right to exercise their ESOPs and purchase company shares at pre-determined prices, which are often lower than the market value. Furthermore, employees who are granted ESOPs can sell their shares to make profits. However, in the event that the employee leaves the company or takes up retirement prior to the end of the vesting period, the organisation must purchase the ESOP back at a fair market value within a 60-day period.

While you now know what ESOPs are, you must also familiarise yourself with the costs involved. The initial costs of ESOPs in India can involve legal fees, accounting charges, and administrative costs. However, the cost of creating and maintaining an ESOP can differ, depending on the plan’s size and complexity.

At the time of exercising their stock option to acquire shares, the employee can either sell them right away or hold them to profit from potential appreciation. If the shares are sold, they will receive the proceeds minus taxes on the gains. On the other hand, if they keep the shares, they will receive a stake in the company and can benefit from dividends or capital gains if there is an increase in the stock prices.