In the last few years, employee reward and recognition programs have taken center stage in the retention strategies of many organizations. Amongst the many ways to reward an employee, incentivizing employees is a crucial aspect. Employee Stock Option Plans (ESOPs) provide an opportunity to incentivize employees and also give them a sense of belongingness and ownership in the company. It is mutually beneficial for the organization and the employees and has often ensured companies’ stability during major transition periods.
What are Employee Stock Options?
ESOPs essentially mean the granting of rights to employees to buy stock of their company. This opens doors to great financial incentives for employees, along with rekindling the feeling of responsibility and ownership of their role in the company.
The process of granting ESOPs involves a few keywords -
- You will be assigned options at a specific price (issue price), which you will hold on to for a specific time period (vesting period) before you decide to buy or sell it.
- After this period, you can exercise your option to buy it at a price lower than the market. This day shall be marked as the exercise date, and the day after which you can exercise your option is called the vesting date.
- You need to ensure that you exercise your options before the specified expiration date.
- The period between the joining date and when an employee enters a vesting period is called cliff vesting.
To understand this better, let us consider a scenario:
You are granted ESOPs of 100 shares of Rs 10 on 25th December 2022, and are told that the purchase must happen before 20th November 2029. You decide to exercise your option on February 25th, 2024 when the price of the stock goes up to Rs 35.
So in this situation,
Issue Price is Rs 10,
The expiration Date is 20th November 2029,
Market Price is Rs 35, and
The exercise Date is 25th February 2024.
What are the Types of ESOPS?
Stock options are generally categorized based on who they are being allotted to, and their general features. There are major ESOP categorizations -
Incentive Stock Options - As you can infer from the name, ISOs are issued specifically for employees, generally in the form of incentives or rewards. Employees can exercise ISOs, i.e., They can buy them at a price less than the market price (which is allotted before the vesting period by the company), with tax benefits
Non-Qualified Stock Options - NSOs are quite similar to ISOs, only that they can also be allotted to partners, investors, and suppliers. However, these do not have the tax exemption benefits like ISOs.
Restricted Stock Units - RSUs are directly linked with milestones. These types of ESOPs can be exercised after achieving a certain performance milestone, or after completing a certain number of years in the organization.
What are the benefits of ESOPs?
ESOPs have the ability to facilitate substantial financial benefits for employees. It cultivates interest in the company’s growth. There are many stories of employees gaining 5-figure or six-figure benefits from ESOPs. Some types of ESOPs provide additional tax benefits to employees. ESOPs provide a sense of ownership and motivation for the employees, as they feel they have a personal stake in the future of this company. This would increase productivity within the organization and also helps in attracting top talent, which signifies its contributions to the overall image of the company.
They are a cost-effective benefit from an organization’s point of view, and there are lesser chances of the company being affected negatively in the market since a lot of the stakeholders are a part of the organization. ESOPs can facilitate the stability of the organization. Even if there is a change in the leadership, ESOPs reduce the chances of the company collapsing financially.
Vega Equity provides a unique experience for the administration and employees alike, where every single aspect of ESOPs - from granting them to establishing timelines to tracking them. This is extensively covered and presented to the user in the form of an interactive dashboard, which is one of the many intuitive features of Vega Equity.
What are the disadvantages of ESOPs?
Even though they possess an array of benefits, ESOPs can sometimes be tricky customer and need regular monitoring and compliance. A few other things need to be kept in mind:
- ESOPs carry with them a fair amount of risk, which can be due to reasons like environmental factors and market fluctuation.
- The profit gained by exercising and selling shares is taxable.
- It is not an ideal choice for startups and small businesses, mostly because of the sheer workload of monitoring and administration that comes with the ESOP transition.
Conclusion
All in all, ESOPs are starting to gain popularity in employee incentive plans, and have become a great tool to engage employees and keep them motivated. With regular monitoring and compliance, it is a great asset for a company to foster its overall and consistent growth.
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