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.
Do they 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.