ESOP
• ESOP full form is Employee Stock Ownership
Plan. Under this plan, employers offer their
employees the stock of the company at a low
or no additional cost that they can encash
after a specified period at a specific
price. ESOP examples in India include those
offered by Flipkart, Myntra, and other
companies when they were starting up.
How Do ESOPs work?
• Employers decide the number of shares to be
offered under ESOPs, their price, and the
beneficiary employees. ESOPs are, then, granted
to employees and a grant date is provided.
• Once ESOPs are offered, they remain in a trust
fund for a specific period, called the vesting
period. Employees should stay with the
organization for the vesting period to avail the
ownership of stock by exercising the ESOP.
• Once the vesting period expires, employees get the right to
exercise their ESOPs. The date on which the vesting period
expires is called the vesting date. Employees can exercise
their ESOPs and buy the company shares at allotted prices,
which are lower than the market value. Employees can also
sell the shares that they have bought through ESOPs and
make a gain on their holdings.
• If the employee leaves the organization or retires before the
vesting period, the company is required to buy back the ESOP
at a fair market value within 60 days.
Benefits of ESOPs for Employees
ESOPs are beneficial for employees in the following ways:
• Stock Ownership
Employees can enjoy ownership in the company that they work for as
ESOPs give them the right to own a part of the company’s share capital.
• Dividend Income
A part of the profit earned by the company is distributed among the
shareholders in the form of dividends. Employees can, therefore, earn
additional dividend income and also get the direct benefit from the efforts
that they put toward the company’s profitability.
• Buy Shares at a Discounted Rate
At the time of exercising the ESOPs, employees usually pay a nominal
amount to buy the shares allotted to them. This, therefore, allows them to
invest in the company at a preferential rate.
Benefits of ESOPs for Employers
ESOPs are favorable for employers too. Here’s how:
• Employee Retention
Since employees have to wait out the vesting period before they can
exercise their ESOPs, it becomes easier to retain employees.
• Better Productivity
Since employees themselves stand to gain from the profits earned by the
company, ESOPs can boost employee productivity and make the company
more profitable.
• A Tool for Attracting Talent
ESOPs are additional compensation plans that help employers attract and
retain talented employees. In fact, for start-ups, ESOPs help lure in good
talent in the initial days when high pay packages are not feasible.
Limitations of ESOP
• There are restrictions on price per share: The performance of
the firm affects ESOP share price. Without sustainable
earnings, the company’s esop value declines (esop share
annual value), which might cause the ESOP share price to
change. ESOPs are best for workers in businesses with a well-
established management strategy that generates predictable
and consistent financial returns.
• Timing: Based on company success, employees may need to
timing their leave in order to maximize the ESOP value. A
reduced payout will be received if you leave the business
when the esop share price is lower. Therefore, time is crucial
to take into account when choosing when to sell shares.
Contd…
• ESOPs Need Constant Upkeep: Because an ESOP is a qualified
retirement plan, even if it invests mostly in employer stocks, it is
also subject to ERISA regulations. The DOL mandates that plan
sponsors conduct yearly, independent appraisals and file a Form
5500. In addition to setting specific guidelines on stock allocation,
vesting, and repurchases. The plan is managed on a day-to-day
basis by a third-party administrator (TPA), just like other defined
contribution plans, such as 401(k)s. The TPA also oversees annual
disclosures, vesting plans, and ESOP share repurchases. The
expenses are comparable to those of other contribution
programmes.
Contd..
• The Process of an ESOP Transaction is Highly
Structured: The US Department of Labor oversees ESOP
regulation, and the IRS has defined official guidelines and
limitations. Because of this, employee ownership
transactions involve difficulties that are uncommon in
standard M&A negotiations. The procedure involves
particular processes, such as figuring out which employees
participate and writing an ESOP plan and summary
description. In addition to dealing with designated
professionals (an institutional trustee, trustee’s counsel, and
an independent valuation company).
