Investment word of the day: Employee stock ownership plans or employee stock option plans (ESOPs) are incentives beyond salaries, and the allotment of shares gives employees a sense of ownership in the company. The incentive aims to promote employee retention and encourage performance. Employees can benefit from selling shares or earning dividends based on company performance. Here’s all you need to know about ESOPs.
What is ESOP?
Employee stock ownership plans, or ESOPs, offer shares of a company to its employees at low or no additional cost. These shares can be encashed after a specific period at a particular price.
How does an ESOP function?
The board of directors or a designated pay committee typically decides the number of ESOPs, eligible employees, and the price at which they have to be offered. ESOPs are offered to eligible employees along with a specified date.
Once offered, ESOPs are maintained as a trust fund for a particular time period, which is known as the vesting period, a timeframe within which employees have to exercise stock options. During this period, employees are expected to stay with the company to avail ESOPs. After the expiry of the vesting period, they get a chance to exercise them.
The expiry date of the vesting period is known as the vesting date. After the vesting date, employees can exercise ESOPs by buying the shares of the company at specific prices, typically lower than the market price. They also have an option to sell these shares.
In a case where the employee resigns or retires before the vesting date, the company must buy back the ESOP at fair market value within 60 days.
What happens after the vesting period?
If employees exercise ESOPs to buy shares, they can either sell them or keep them. When selling the shares, employees can take advantage of gains apart from the taxes levied. On keeping the shares, employees will own a part of the company and become eligible for dividends or capital gains when the share prices perform well.
Cost of ESOPs
In India, ESOPs account for several costs, such as legal fees, accounting expenses, and administrative costs. The expenses will depend on the company’s financial health, trends in the market, and the size and complexity of the ESOP plan.
Why do companies offer ESOPs?
ESOPs are a measure through which companies try to retain employees and attract new talent. They are also provided with the belief that employees will work better if they feel they own a part of the company.
Disclaimer: This article is for informational purposes only and does not constitute financial advice; please consult a qualified financial advisor before making any financial decisions.
