In a recent news item, Paytm is now allowing its employees to turn their ESOPs into shares making them shareholders before the initial public offering.

So what are basically ESOPs?

ESOPs or employee stock ownership plan (ESOP) is a kind of benefit plan for the employees which offers an ownership interest to them in a firm. A number of firms across the world use this plan as a part of an annual payment structure for employees.

It could be issued as stocks or in a profit-sharing model as well as bonuses.

How does it work?

So basically, a company issuing ESOPs to its employees means they can buy a specified number of shares in the firm at a defined price after a specific amount of time. The employee has to be part of the organisation for that amount of time before he/she can exercise this option.

Why do companies offer such a plan?

It is mainly intended to keep employees for a longer-term by giving them ownership in the firm. Some companies have a higher attrition rate and this helps bring that down since the employees have to serve a specific amount of time with the organization to become shareholders.

This helps improve the performance of a firm as well as its value as its shareholders are also employees. It also helps in minimizing problems related to incentives especially for companies with some cash flow issues.

If your company is offering ESOPs, key questions to ask before agreeing:

a) What is the vesting period for the ESOPs, which means after what amount of time working in the organisation he can ask for these options to be converted in shares.

b) What price has been agreed on for the ESOPs? For instance, suppose a firm is giving 100 options at ₹10 face value with a vesting period of one year. So when after the period is complete, the employee wants to turn 50 percent of his options to stocks, so for 50 shares, he will have to pay 50*10 which is ₹500 to the firm at that time.

c) What happens if the employee quits before converting all the options to shares?

d) what happens to the ESOPs if the firm fires the employee or shuts down?

The employer, as well as the employee, must understand the legal implications of ESOPs before agreeing to it and have clarity on the terms and conditions for the same.