Employee Stock Option Plan (ESOP) is an employee benefit scheme under which the company encourages its employees to acquire ownership in the form of shares. These shares are allotted to the employees at a rate considerably lesser than the prevailing market rate. Apart from the employee-benefit motive, ESOPs are also meant to align the interests of the employees with that of the shareholders. It is believed that the employees, who are also the shareholders, will focus better on company performance and growth so that the value of their shares appreciates.
Essentially, the employees of a company are entitled to the Employee Stock Option Plan (ESOP) but the Company sets a certain criteria to make employees eligible for the same. Benefits under the ESOP scheme can be claimed by:
- A permanent employee of the company working in or outside India
- A part-time or whole-time director of the company
- An employee of holding, subsidiary or associate company, whether in India or outside India
Promoters or Directors of the company holding more than 10 percent of its equity cannot take part in an ESOP.
Under the Employee Stock Option Plan (ESOP), the company grants its employees an option to buy a certain number of shares at a predefined price which is usually lower than the market price. ESOPs in India are governed by the Companies (Share Capital and Debenture) Rules, 2014. ESOPs are common among early-stage start-ups. From a start-up’s perspective, these are the steps to offering an ESOP-
- First of all, the company drafts an ESOP scheme and gets it approved in a shareholder’s meeting. Previously, this scheme required an approval by a ‘special resolution’ and filed with the Registrar of Companies, thereafter. But with effect from 5th June 2015, private limited companies do not have to comply with this rule.
- After approval of the ESOP scheme in a shareholder’s meeting, a ‘Letter of Grant’ should be issued to the concerned employees. This letter should contain information about the number of options granted, vesting period, calculation of the exercise price, etc. One should note here that options are not shares; it is just the right to own shares.
- If an employee wishes to exercise this option granted to him by the sponsoring company, he needs to make an ‘Exercise Application’. After this, his options will be converted into equity.
In most of the cases, either the employees do not fully understand the ESOP granted to them or the employer is not able to educate its employees about the same. Hence, it is important to understand the following terms related to ESOPs:
Grant: The grant of an ESOP refers to the commitment made by the employer by issuing the ‘Letter of Grant’ informing concerned employees about their eligibility to avail benefits under the scheme.
Vesting: It is the process which gives an employee the right to own shares in his company over a period of time. The rights over these shares are non-forfeitable.
Exercise: The company, initially, grants an Option. If an employee decides to convert this option into shares, it is called ‘exercising’ the option.
Exercise Price: Also known as Strike Price, this is the price at which these shares are offered to the employees. It is usually below the current market price and is pre-determined. The employee has to pay the strike price and own the equivalent shares.
Exercise Period: After the vesting period, the employees are given some time to exercise the options granted to them. This is known as ‘Exercise Period’.
Benefits for Employees:
Employees also enjoy several benefits of an ESOP:
- ESOPs definitely bring financial benefits to the employees in the form of higher pay, benefits and overall wealth generation. It also allows a comfortable retirement for them.
- Holding the shares of the company, they feel more responsible towards the organization. They actively participate in the company’s decision making processes which, in turn, make them more optimistic towards the organization.
- As a combined effect of monetary and non-monetary benefits, ESOP gives better job security and job satisfaction to the employees.