scorecardresearchESOPs - All you need to know

ESOPs - All you need to know

Updated: 17 Mar 2022, 10:32 PM IST

ESOP is an acronym for Employees Stock Ownership Plan. As the name implies, this is a program that allows employees to become shareholders in the firm. This option is available once the employee has worked for the firm for a certain number of years. Continue reading to know more about ESOPs.

ESOPs can bring a windfall of money for employees and co-founders.

ESOPs can bring a windfall of money for employees and co-founders.

An employee stock ownership plan (ESOP) grants employees company shares, often based on the duration of their employment. Typically, it is part of a compensation package, where shares will vest over a period of time. ESOPs are designed so that employees’ motivations are aligned with the company’s growth. From a company’s perspective, ESOPs have certain tax advantages, along with incentivizing employees to focus on the company’s performance.

What is an ESOP?

ESOPs are perhaps one of the most important types of employee compensation. From the standpoint of a startup, it helps to preserve liquidity, and from the perspective of an employee, it is a reward for loyalty.

Definition of ESOP

ESOP is a form of employee benefit plan that encourages employees to buy shares in the firm or become shareholders. The employer offers the employee-specific company stocks for no or little cost, which stays invested in the ESOP trust fund until the employee's options vest and they execute them, or they exit the firm.

Consider the case of an employee who has been working at a big software company for five years. They have the right to obtain 20 shares after the first year under the company's employee stock ownership plan, and a total of 100 shares after five years. When the employee retires, the value of their stock will be paid to them in cash.

Understanding ESOP Taxation

When a specified time period from the date of grant has passed, shares are vested in the employees (vesting), which means that the employee has an unrestricted right to receive the shares. Once such alternatives have been granted to the employee, he has the right to exercise them (exercise). When an employee exercises his or her stock options, the company allots shares to the employee (allotment). In India, ESOPs are awarded in accordance with the SEBI Guidelines of 1999.

ESOP taxes are determined at two levels:

1. A first levy occurs when an employee's shares are allotted to him after he has exercised his option and the vesting period has ended

The difference between the fair market value of the shares on the exercise date and the amount paid by the employee for the exercise or subscription to the shares is computed and taxed at the time of allotment of shares on the exercise date. Perquisite value is the name given to this taxable worth.

2. An employee chooses to sell his or her ESOP authorized shares, a second charge is imposed

When an employee sells the shares that were given to him under an ESOP, he must pay tax on any earnings or gains that result from the transaction. Such profit is subject to taxation under the heading of "Capital Gains." Capital gains are further divided into two categories: ‘Short Term Capital Gains' and ‘Long Term Capital Gains,' depending on how long the shares have been held.

It can be said that an ESOP is a way for employees to invest in their employer's business. The plan's objective is to match workers' interests with the interests of the company's shareholders.

Employees are elevated from employees to owners of the firm when they are given a share in it. Employees are motivated to perform better since they are shareholders as well. In the company meetings, the possession of shares determines the voting power. Since senior workers are given more shares than newly hired employees, the latter have less voting power at shareholder meetings.

What are some key terms related to ESOP?

Before delving into the specifics of an ESOP, it's important to grasp a few essential terminology. Let's go through some of the key ESOP terminology.


A permanent employee of a firm who works in India or outside of India is referred to as an employee. This would also include any subsidiary or affiliate company's full-time and independent directors, as well as their workers.

Compensation for employees

This phrase refers to the overall cost to the firm of an employee's compensation, which includes his basic salary, bonus, and any commissions. Employee remuneration does not include the fair value of options issued under an employee stock ownership plan. Employee pay does not include the discounts received when shares are distributed to employees under an ESOP.


This phrase refers to an employee's request to the firm to issue shares in exchange for the option he has vested in line with ESOP.

Exercise period

It refers to the amount of time an employee has after becoming vested in an employee stock ownership plan to exercise his options.

Exercise cost

It is the amount that an employee must pay to the firm in order for the corporation to issue him shares under the ESOP.


This phrase refers to the distribution of options to workers under an employee stock ownership scheme.

Independent director

He is the company's director. He may or may not be a full-time director, and he is not a promoter or a member of the company's promoters group.

Intrinsic worth

This phrase refers to the difference between the market price of a share as part of ESOP and the exercise price of the option, including any upfront payments.


The process by which an employee obtains full rights to the options issued to him under an ESOP is known as vesting.

Period of vesting

The time during which the employee's ESOP option matures.

Market price

This refers to the most recent accessible closing price on the stock market where the company's shares are listed prior to the date of the board of directors meeting at which options are granted or shares are issued.

Option grantee

This word denotes that an employee has the right but not the obligation to execute his or her stock option under an employee stock ownership plan.

Cliff period

The time after the grant date when the first options become vested is known as the cliff period. It is necessary in India to have a cliff period of at least 12 months.

ESOPs are frequently used by companies to recruit and retain high-quality employees. Stocks are often distributed in stages by organisations. ESOPs allow employees to purchase business stock at a minimal price and then sell them (after a predetermined period of time established by their employer) for a profit.

The ESOP's initials may be easier to grasp if an investor is familiar with the terms described above. Hence, knowing these key phrases is seen as a wonderful beginning step.

ESOP is a form of employee benefit plan that encourages employees to buy shares in the firm or become shareholders.


What are the types of ESOP?

The types of Employee Stock Ownership Plans that are commonly given to workers are as follows:

Employee Stock Purchase Plan (ESPP)

At grant/exercise, an employee may acquire shares at a discount to the market price, which is usually set at a reduced price. A plan term determines the price and date at which an employee can acquire company stock. This is called an Employee Stock Purchase Plan.

Employee Stock Option Scheme (ESOS)

Employees who participate in the Employee Stock Option Scheme are not obligated to exercise their stock options, but they can at a predetermined price. Before vesting, the employee must meet a goal or serve for a certain period of time. The employee can then exercise his or her option to acquire the shares at the predetermined price.

Restricted Stock Award (RSA)

If an employee satisfies the employer's pre-set requirements, the employee is offered shares in the firm along with certain voting rights and is entitled to dividend. If the employee does not fulfil them, they will no longer be entitled to receive the company's stock. The employer's requirements may relate to spending a certain time period or to a specific goal.

The Restricted Stock Award can be purchased at a lower price than market value. In most cases, there are no fees associated with stocks. Employees who participate in such ESOPs own the shares from the start and are entitled for bonuses and dividends during the vesting period.

Phantom Equity Plan (PEP)

Employees are offered shares in the firm in theory through a Phantom Equity Plan (PEP) or a Stock Appreciation Right (SAR). After they meet the vesting criteria, they may get a cash value equivalent to the price appreciation above the grant price.

Restricted Stock Unit (RSU)

The Restricted Stock Unit and the Restricted Stock Award are quite similar. The key distinction is that the employee does not have any voting rights or right to dividends. Once the predetermined requirements are satisfied, the employee can exercise the shares issued by the company. 

Restricted Stock Units are not immediately transferred to the employee. However, in the future or under certain conditions, the employee may be entitled to partial dividends.

Companies can finance ESOPs by placing freshly issued shares into them, putting cash into them to acquire existing business shares, or borrowing money to buy company shares via the organisation.

The above-mentioned plans motivate members to do what's best for the shareholders.

How is an ESOP determined?

Although there is no standard framework for creating an ESOP, businesses can specify their own set of regulations in this important document. They must, however, follow SEBI's statutory requirements as well as the Companies Act of 2013. Let's take a look at the elements to consider when creating an ESOP.

Pool Dimensions

This is generally defined in the Shareholding Agreement for financed businesses (SHA). Again, there is no set formula or guideline, although in the early stages, a pool size of 10-15% should suffice. In future financing rounds, it is extremely usual to increase the pool size.

Employee Eligibility Criteria

Based on employment duration, performance, seniority, future potential, and other factors, these determine whether an employee is qualified for a grant or vested option.

ESOP Distribution

It can be done in a variety of ways. In India, however, most entrepreneurs choose the straight way and manage the process themselves. This method is considerably more straightforward. The grants are approved by the board of directors, or a small committee is created to do so. The other option is to distribute via an ESOP trust. This is a time-consuming approach that necessitates additional accounting tasks. As a result, just a few businesses choose it.

Vesting and Lock-In Period

Even when employees are given stock options, they do not become owners of the shares straight once. Simply explained, vesting is the process of applying for and purchasing a company's stock after a set length of time has elapsed and specific criteria have been satisfied according to the company's regulations.

The vesting time must be at least a year between when the stock option is granted and when it is exercised. The vesting time after which an employee can apply for the shares given must be specified in the ESOP. It should also allow the administration committee to set a lock-in period during which an employee is unable to redeem or sell his/her shares.

Former Employees' Exercising Period

Because ESOP shares are often equity shares, even a former employee may be able to keep them. In its ESOS, a business can define how long it wants its workers to exercise their stock options after they leave the company.

Exercise Process and Plan

The exercise duration and the exercise cost are both included in an exercise plan. The exercise period is the time after the vesting period during which an interested employee must exercise his/her right to apply for and pay for the company's shares. It's crucial to stress that acquiring these shares is a choice, not a requirement, for employees.

If all criteria are met and an employee agrees to purchase the shares, the exercise price, which is less than the fair market value (FMV), might be paid. Employees must be able to exercise their ESOP options in some form or another, and the firm must have a framework in place to allow them to do so.

Buybacks of ESOPs

Even in the midst of the Covid-19 epidemic, several Indian businesses launched ESOP buyback programmes, letting employees to cash in their stock options. An ESOP buyback occurs when an employee surrenders or forfeits his/her ESOP grant, and the business rewards the employee with a bonus equal to the amount surrendered.

ESOS Amendment/Termination

The ESOS of a firm must answer the following questions: Who has the authority to change the ESOP and under what conditions? Is it possible to cancel the plan before it expires? If that's the case, who would have the authority to terminate the ESOP and under what conditions? Covering these questions are considered essential while drafting an ESOP.

ESOPs are a company's option or right, but not a requirement, to acquire its shares at a predetermined price in the future. Employee stock ownership plans connect employees' interests with the long-term interests of firms and play a critical role in retaining employees during a company's growth stage. Hence, considering the above factors helps in understanding and determining the correct ESOP for an employee as well as the employer.

What are the Benefits and Drawbacks of ESOPs?

Giving ESOPs is a common trend in start-ups, where firms provide employees the opportunity to preserve significant cash outflows in lieu of a high wage, when resources are limited. This encourages workers at all levels to perform at their best and assure the company's success, since they will profit from the company's success as well.

ESOPs are not for everyone, as appealing as they may appear. They come with stringent requirements, as well as several limits and obligations. The ability of your firm to use such a plan is determined by its structure, and not every organisation fulfils the legal criteria. While tax benefits are appealing, they are also highly regulated and dependent on a variety of factors, including the business's structure.

Let us discuss the benefits and drawbacks of ESOPs in detail.

Benefits of ESOP

Employee stock ownership plans (ESOPs) provide long-term benefits to employees. It may be an appealing component of an employee benefit package, similar to a solid healthcare plan or competitive paid time off, and can help recruit top talent to the firm. It can enable team members to accumulate considerable wealth over time as their shares grow in value.

ESOPs promote a sense of ownership, cooperation, and employee retention. It may boost employee morale by ensuring that everyone is invested in the company's success. It's a win-win situation for both team members and the firm when they think strategically and try to execute their tasks well.

ESOPs provide significant tax and investment advantages. Because they are tax-exempt trusts, the company's profits are distributed to the employees — and that's only the beginning. An S-corporation that is 100 percent employee-owned avoids paying taxes, resulting in increased profits right away. You should get advice from a tax professional.

ESOPs can take less time to implement than an external sale. An external, third-party sale may be a long and complicated procedure with a lot of moving pieces. An ESOP might be an enticing alternative for owners who want to exit the firm quickly.

ESOPs allow for both an immediate and a gradual change of ownership. With an ESOP, the existing business owner can choose whether to sell all of his or her shares at once or to stay a partner and progressively transition ownership over time. Furthermore, establishing an ESOP to provide liquidity for a minority ownership does not prevent a later sale to a third party.

Drawbacks of ESOP

The proceeds from a sale to an ESOP may not be maximised by current shareholders. Because an ESOP is a financial rather than a strategic buyer, it can only pay the present owner fair market value. A rival, on the other hand, may offer a premium to buy the firm, and the present owners might get top cash.

To thrive throughout an ESOP transition, businesses must have excellent management. There's a lot riding on the present owner's departure from corporate leadership, especially if he or she started the firm. Strong leadership is required to change the ownership structure.

ESOPs need continuous management and experience. It involves a variety of costs, ranging from yearly valuation and plan administration to legal and perhaps trustee fees.

Startups and extremely small enterprises should avoid ESOPs. Only C and S corporations, not partnerships or most professional corporations, can employ ESOPs. The cash flow allocated to the ESOP might limit what can be reinvested in day-to-day operations, which can be a problem for early-stage firms. Because shares must be repurchased when an employee leaves, a small firm might face a significant future expenditure if a large number of employees leave at the same time.

Key takeaway

In the end, whether or not this is appropriate for you is determined by your own circumstances. It may be wonderful, or it might be a legal nightmare. There is no formula for success. Only a comprehensive review of your particular circumstances can reveal what is best for your company. Setting up an ESOP, like any other company transformation, takes time and strategy. With so many rules and intricate criteria, consulting a specialist to decide the best course for your company will save your time, money, and legal problems.

How does an ESOP work in India?

When an employee receives an Employee Stock Ownership Plan (ESOP) from his or her employer, he or she gains the right to acquire a specified number of shares in the firm at a predetermined price after a set time or period. It is usually given as a reward for a good performance or for staying with the firm for a long time.


ESOP is a type of employee benefit plan that gives employees a share of the company's ownership. It allows employees to acquire a set number of business shares at a set price when the option period expires (a certain number of years).

Before an employee may exercise his option, he must first complete the predetermined vesting period, which requires the employee to work for the company until a portion or all of his stock options are exercised.

ESOPs are probably the most important type of employee compensation. From the standpoint of a startup, it helps to preserve liquidity, and from the standpoint of an employee, it is a reward for loyalty. ESOPs, like almost everything else in life, are not easy. Let us try to understand how they work.

Working of an ESOP from an employer’s perspective

A firm cannot simply offer options to its employees by sending a simple letter. When issuing ESOPs, they must adhere to a set of procedures.

The employer prepares an ESOP plan and gets it approved at a shareholders meeting. This plan is required to be authorised by a "special resolution" and lodged with the Registrar of Companies until June 2015. (ROC). Private limited businesses are no longer required to comply with Section 62(1)(b) of the Companies Act, 2013, which formerly required ESOP plans to be authorised by a "special resolution" and to publish their essential conditions with the ROC, making all of this information publicly available.

Once an ESOP plan is authorised, the employee gets a letter of grant notifying him of the number of options he has been awarded, the vesting period, and how the exercise price would be calculated if he chooses to exercise the vested options.

If an employee chooses to exercise any of his vested options, he must submit an exercise application to his employer business, which will convert his options into stock.

Working of an ESOP from an employee’s perspective

Whenever an employee is awarded stock options, he or she may request a copy of the ESOP programme from the beginning. This programme will provide a thorough understanding of the terms and conditions of ESOPs.

There is a one-year cliff period once stock options are issued. After the cliff period has passed, any vesting, i.e. the right to convert stock options into equity, will take place.

Following that, the employee will have the opportunity to exercise his vested options by paying an exercise price to the employer, subject to the vesting schedule, which specifies how vesting should occur.

The exercise price is usually equal to the share's face value. The entire exercise procedure can also be made cashless, i.e., vested options can be exercised and converted into equity without having to pay anything. The ESOP plan and/or the employer's letter of grant will emphasise all of this information.

How do ESOPs truly compensate for the wage reduction?

There is no right formula to be used in this situation. An employee must recognise the worth of what they are being provided. It isn't considered accurate to claim your CTC as INR 20 lacs because you're getting INR 15 lacs in fixed compensation + INR 5 lacs in stock options (as on date).

Because the stocks are never instantly vested, the founders prefer that you stay for a fair period of time (say, four years) to be eligible for the rewards. Second, the stock's current value is only a rough estimate. Before such figures become relevant and of any actual (financial) worth, the startup must be tremendously successful.

ESOPs are a brilliant way to encourage employees to invest their heart and soul into a company. However, the award of options does not guarantee that the employee will leave the company with millions in his bank account, and workers should be aware of this.

Most young employees are familiar with only the positives of ESOPs and often skip their homework to learn the essential phrases that control their possibilities. Some businesses hire their legal counsel to give a presentation to their whole team about how ESOPs operate and how they may benefit them which is considered a great initiative as failure to grasp the nuances might leave the employee unsatisfied when they quit to move on to their next position.

Why are ESOPs becoming more popular in startups?

When a corporation or a startup decides to implement an employee stock ownership plan, they have two major goals in mind, to give workers company shares as a reward for their good work, and to make the company grow.

It is a common question that comes to mind after learning about the problems that start-ups face: how is it possible for a start-up to retain its top employees who are building the company from the ground up when they are unable to pay them hefty salaries that will keep them happy, satisfied, and motivated to work and keep working for the company?

An excellent solution to this problem that is highly popular in start-ups - employee stock ownership plan, or ESOP. When a firm or a startup chooses the employee stock ownership plan, they have two primary aims - to provide company shares to employees as a bonus or reward for their hard work, and to motivate them to work for the company’s growth. 

The first is to employ the best in the market or industry, and the second is to keep the best that they have hired for a long time, both of which may help the company make the most of its hiring and turn a profit, as well as achieve the break-even point faster and more efficiently.

Let us understand some major points in detail.

They provide an appealing exit strategy for owners

Employee stock ownership plans (ESOPs) provide employees equity ownership in the firm. As a result, employees become part-owners in the business. Some entrepreneurs form an ESOP as an exit strategy if they decide to quit their businesses. Making an ESOP before leaving a business also ensures that any stocks held in cash on the day of the sale are sold at their fair market value. Furthermore, even if a person just sells a portion of their ownership stake, they retain control until the whole money is received.

Boost employee productivity and morale

Various studies, however, show that capital-sharing arrangements, such as ESOPs, might increase employee satisfaction and motivate people to work more than they would otherwise. According to another study, ESOP firms expanded 5% quicker than non-ESOP enterprises. This might happen, in part, because employees are emotionally involved in the firm and want to assist it achieve its objectives.

Retain employees even if they are paid less

One of the most common challenges faced by startup owners is to determine how to retain staff motivated despite lower-than-average compensation. Because ESOPs provide workers with ownership holdings, they may assist future and present employees realise that benefits come in a variety of shapes and sizes.

Employee stock ownership plans (ESOPs) can provide employees a stronger feeling of belonging, enhancing their long-term commitment to the firm. As a performance reward, employees in an ESOP might get stock options. If the company can't afford to pay them regular incentives, stock options are another way to express appreciation for good performance.

What are the downsides of ESOP lifelines for startups?

When you consider the possible tax benefits and consequences for your workers, ESOPs might be an appealing idea, but it should be approached with caution. This strategy is not appropriate for every firm. It might turn out to be complicated, costly and unviable for certain firms. It can also expose a company to legal action, so firms should make sure that they are aware of the dangers and choices before proceeding.

While tax benefits are appealing, they are also highly regulated and dependent on a variety of factors, including the business's structure. Let us discuss some major drawbacks of ESOPs.

Payout is lower

Employees in a closely held ESOP may not receive the same share price as they would if the shares were publicly traded.

Difficulties with cash flow

The cash flow allocated to the ESOP might limit what can be reinvested in day-to-day operations, which can be a problem for early-stage firms. Because shares must be repurchased when an employee leaves, a small firm might face a significant future expenditure if a large number of employees leave at the same time.

Expenses are high

Companies that adopt ESOP programmes may expect to pay a lot of money to set up and run them as they need continuous management and experience. Hence, it involves a variety of costs, ranging from yearly valuation and plan administration to legal and perhaps trustee fees.

Dilution of the stock price

The creation and issuing of extra shares for new participants can dilute the value of all existing shares, which is a particularly serious issue for closely held firms.

Requires great management

To thrive throughout an ESOP transition, businesses must have excellent management. There's a lot riding on the present owner's departure from corporate leadership, especially if he or she started the firm. Strong leadership is required to change the ownership structure.

Of course, there are drawbacks to every qualifying employee benefit plan. Valuation, legal and regulatory advice, competent plan management, financing, and fiduciary duty are all part of an ESOP transaction. To fully profit from the ESOP, owners must be informed of the legal and tax implications.

Why shouldn't you be misled by startup ESOP options?

Employees may be at risk if they participate in an ESOP. When the ESOP takes on too much debt, it puts employees' ESOP funds at danger. When an ESOP takes on considerable debt, it leaves little room for the sponsoring firm, which is now owned by the employees, to weather a financial collapse.

Firms contemplating an ESOP should be aware that the risks encountered by privately owned companies differ from those faced by publicly held companies, and companies considering an ESOP should be aware of these distinctions while weighing the risks involved with an ESOP.

Major ESOP risks

The value of a company's stock might be affected by its financial conditions, reducing the stock's value and jeopardising the value of employees' ESOP accounts.

If a company with an ESOP is having financial difficulties and needs to lay off employees, the plan must cash out those employees' ESOP shares, which can cause even more cash flow issues and lead to more layoffs.

If a company's ESOP is invested in privately traded stock, the dangers stated above are amplified since the stock's value is set by a third party who may or may not be unbiased, rather than the stock market.

What happens if an ESOP firm runs into financial difficulties?

When employees rely on the same employer for both their income and their retirement account, they face an additional risk. When a firm faces financial obstructions, In most cases, the stock price falls, putting members' retirement savings at risk. Layoffs are common, exacerbating the situation. Employees may now be out of job, their retirement funds may be dwindling, and they may have little financial stability to fall back on when they need it most.

What happens if an ESOP firm is sold?

When a firm is sold, the ESOP is typically terminated, and employee owners get cash for their stock. This might be a good way to diversify your assets and get greater control over your money outside of the ESOP. Your firm may be sold to a company that has its own ESOP in some situations. This usually results in a rollover of part or all of your ESOP shares into the new company's ESOP shares.

An ESOP may be a good fit if certain requirements are satisfied and a skilled group of advisers is hired to help the firm through the legal, accounting, and administrative processes. While there is always a danger of failure, the potential is enormous. Maintaining an ESOP comes with a lot of risk, but it also comes with a lot of advantages and rewards. Hence, all the aspects of ESOPs should be studied carefully before choosing one.

Getting ESOPs as a salary package? Here’s why you should consider them

ESOPs are regarded as a desirable alternative since workers can directly participate in the company's success by holding shares and can reap financial benefits by selling shares that were bought at a cheaper rate. Employee Stock Option Plan, or ESOP, is no longer a foreign concept in the Indian startup world.

ESOPs were once used to reward and recognise senior workers' efforts, currently, they are used to decrease fund-shed or to provide employees a sense of ownership and, hence, a greater sense of responsibility. To begin, ESOPs are programmes that allow employees to acquire a specific number of the company's shares in exchange for a wage. This effectively gives them a share of the firm. The risk element on the shoulders of the founder is also minimised.

ESOPs have long been offered by firms such as Flipkart, Facebook, and Amazon, and a growing number of Indian startups are following suit. There are several examples of ESOPs that have grown into significant riches over time, for example, employees who worked primarily on ESOPs at firms like Facebook are now billionaires. Let us discuss some major advantages of ESOPs.

Why should you consider ESOPs?

ESOPs are a tax-advantaged liquidity solution that provides shareholders with fair value.

Entrepreneurs frequently have a variety of liquidity options at their disposal when it comes to generating shareholder liquidity. ESOPs purchase business stock at fair market value, which is roughly the same as a private equity buyer.

Employee Stock Ownership Plans (ESOPs) reward employees who have contributed to the company's wealth creation

Employee stock ownership plans (ESOPs) provide employees with the chance to build wealth while contributing to the company's success. Employees profit from ESOPs because they generate retirement savings that are considerably higher than those available via conventional retirement plans.

Using an employee stock ownership plan (ESOP) in your company develops and protects a legacy

Many entrepreneurs see their businesses as both an investment and a purpose. The company is the result of a lifetime's worth of labour, as well as value and values-driven judgments. Outside financial purchasers are frequently ill-equipped to recognise the company's true worth and values. 

Employee stock ownership plans (ESOPs) and employee ownership can help to maintain the founders' and important entrepreneurs' legacies while allowing a new generation to carry on the company's heritage.

But, before taking ESOPs from a startup, keep the following points in mind.

Period of vesting

Option to acquire shares at a reduced price can be exercised after a pre decided time period has passed. The vesting period can last up to four years in most cases. If an employee leaves or is dismissed before the vesting period, the ESOPs are forfeited.

Calculations for taxes

Employee stock ownership plans (ESOPs) are taxed as part of an employee's benefits package. However, you should be aware that if you sell the shares, the difference between the sale price and the fair market value would be liable to personal capital gains tax.

Chances awareness

One point to remember is that you can get ESOPs from a startup instead of a publicly traded corporation. There are several options for cashing out before the firm goes public. Acquisition would be advantageous, but that is still another game of luck. The equities are transferred to the acquiring firm in the event of an acquisition, and ESOP holders are able to cash out a portion of their shares.

Clauses of agreement

It is critical to read the conditions of the agreement carefully before signing them. When Skype let off a few employees a few years ago, they were only permitted to keep the vested portion of their shares. This was allegedly done in accordance with one of the terms of their agreement, which some of the workers may not have noticed when they signed.

Money matters

Although ESOPs are not considered a cost to the business (CTC), keep in mind that you are foregoing a portion of your income in exchange for an ESOP. Since you are not a direct owner, it is not a bad idea to weigh the pros and cons of a good CTC vs a CTC with ESOPs. Make the decision that you will not be sorry for all of the hard effort you will put in.

Evaluation of the startup's scope

Given the way startups come and go, determine whether the firm has the potential to continue in the market for at least four years. Before accepting ESOPs from an early stage business, it's critical to understand the idea's scalability. Consistently poor corporate performance might jeopardise the value of the ESOPs. Limiting the number of stocks you can acquire is the greatest approach to cope with this.

Accepting ESOPs can be seen as a gamble of sorts since nine out of ten startups fail. The outcome, like gambling, is entirely dependent on how you play.

Summing up

Employee stock ownership plans, or ESOPs, are slowly gaining traction in the Indian startup environment as a way to reward, retain, and recruit employees. When team members become stakeholders, they get several benefits as trust is built and the company's focus on value creation and wealth-building benefits them in the long run. It also allows firms to hire and retain people without depleting their financial reserves, as well as take advantage of tax benefits.

Understanding the foundations of the employee stock/share ownership plan is critical for any entrepreneur or company interested in launching an ESOP program. It is the most important legal document since it contains all of the regulations that govern ESOPs’ activities.

First Published: 08 Mar 2022, 11:16 AM IST