Home / Employee Stock Option Plan (ESOP)

Updated on 21 Oct 2020  9.00 AM IST | 4 min read

What is ESOP?

Employee stock option plan is the plan formulated to encourage employees to acquire ownership in the form of shares. In ESOP, the shares are allotted to the employees at a reduced rate than the current market rate. It is done by the companies to attract, motivate and retain the employees. It is basically a contract between a company & its employees that gives right to employees to purchase specific number of shares at a price lesser than the market price within a certain period of time. The fixed price at which the employee purchases the shares of the company is called the exercise price. In case company’s stock price falls below the exercise price, the company revalues the price immediately to retain their employees.


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ESOP Glossary Terms

  • Grant date – The date on which employer enters into an agreement with the employee and offers them company shares to buy at a future date.
  • Vesting date – The date on which employee agrees to purchase the shares of the company by accepting the specified terms & conditions.
  • Vesting period – Vesting period is the difference between the grant date and the vesting date
  • Exercise period – Exercise period is the period when an employee is eligible to buy the shares after being vested.
  • Exercise date – The date on which employee exercise the option is known as exercise date.
  • Exercise Price – The price at which the employee may exercise the option is known as Exercise price. Exercise price is usually lower than the existing fair market value of the share.

Who Is Entitled To ESOP?

The employees of the company are entitled to the ESOP but company specified certain criteria to make employees eligible for it. ESOP scheme can be claimed by –

  • Permanent employees of the company working inside or outside India.
  • A part time or full time director of the company
  • An employee working in a holding, subsidiary or associate company within or outside India.

Note – Promoters or directors holding more than 10 percent of the equity are not eligible for ESOP.


How An ESOP Works??

The step by step procedure of how an ESOP works is explained below –

  • In the first step, company formulates a plan for ESOP scheme and gets the approval for the same from the shareholder’s in a shareholder’s meeting. Previously, this scheme was filed with the ROC after getting approval by passing a special resolution but from 5th June 2015 onwards, private limited companies rule has been changed and they don’t have to comply with the same.
  • After getting approval in a shareholder’s meeting for ESOP scheme, “a letter of grant” must be issued to all the eligible employees. The letter of grant should contain the information about the following –
    1. Number of options granted
    2. Calculation of the exercise price
    3. Vesting period
  • In the third step, employee of the company should make an “exercise application” if he wishes to exercise the option granted to him. After making an exercise application, his options will be easily converted into equity.

Benefits Of Employee Stock Option Plan (ESOP)

Employee stock option plan offers benefits to the company as well as to employees who choose to exercise the option.


Benefits of ESOP For Company

  • It motivates the employees and creates ownership interest in them to work together for a common goal i.e. company growth.
  • Employees become more loyal towards the company.
  • The brainstorming sessions are conducted to find new techniques to increase company’s productivity.
  • Employees work in unity to reduce the wastage in the organization
  • It increases the trust factor of the working employee in the management and company too.
  • Due to highly motivated workforce, employees try to achieve more & more to increase the company’s share value.

Benefits of ESOP For Employees

ESOP offers several benefits to employees –

  1. Employee stock option plan brings various financial benefits to the employees of the company such as higher pay, overall wealth generation, other benefits etc.
  2. Employees feel more responsible towards the organization by holding the shares of the company. They also participate in the decision making process of the organization which make their attitude more positive towards the organization in future.
  3. After getting both monetary & non-monetary benefits from the organization. Employees feel more satisfied and more secured in job. Therefore, ESOP helps in satisfying the employees too.

Tax Implications Of ESOP

  • Options provided by the company are not taxable
  • Vested options are not taxable
  • Company offers shares to employees at a less price in comparison to fair market value price. The price at which the employee may exercise the option is known as exercise price.
  • When employee exercises the option of buying shares, the tax will be imposed on the employees as per the tax bracket based on the difference between the market value of the shares & exercise value of the shares.
  • If the employee sells its shares after increase in the price of share, it is considered as capital gains whereas loss in selling the shares is known as capital loss. If an employee sells the shares within 1 year, 15% tax is levied against the capital gain but if employee sells the shares after 1 year, he will not be taxable and they are considered as long term assets.
  • If an employee is working in a company based in abroad and having employee stock option plan too, the shares sold by the employee and the amount received will be considered as short term capital gain & will be added to the income of the employee. The employee will be taxed, if it falls into the income tax brackets (whichever may be)
  • If there are long term capital gains –
    1. 20% of tax levied with the benefit of indexation.
    2. 10% of tax levied without the benefit of indexation.

Disadvantages of Employee Stock Option Plan (ESOP)

  1. The liquidity benefits with ESOP’S is highly uncertain
  2. The company’s only hope for compensation is indirectly through increased liquidity and through tax advantage sometimes. Therefore, the risk for exercise remains for the same and this can make options riskier than normal stocks.
  3. There are still many unclear guidelines for valuation & accounting procedures of employee stock option plans (ESOP’S) in a company.

Employee Stock Option Plan (ESOP) FAQ’S

No, ESOP’s are not available for lifetime and they are only valid until the exercise period. After ending of exercise period, they cannot be converted into shares. It also expires when an employee terminated or leaves the organization. It is usually specified in the grant letter.
Granting of ESOP will not make you a shareholder. You have to pay the exercise price to exercise the option and convert it into shares. Converting the same into shares will make you a shareholder.
There are many corporate and legal compliances in relation to ESOP’S. SEBI, income tax act and companies act governs the ESOP’S.
Yes, it can be changed and these changes are made in favour of the employees.
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