ESOPs or Employee Stock Option Plans refers to an employee benefit plan which offers employees a fraction of ownership in the organization. When an employee gets ESOPs from the company where he/she is employed, he/she gets the right to purchase a certain number of shares in the company at a predetermined price after a predetermined period which means ESOPs enable an employee to get the advantages of acquiring the company’s shares at the nominal rate, and sell them (after a defined tenure fixed by his employer) and create profit.
- It is also known as Employee Stock Ownership Plans in India.
- Usually, it is offered as a reward for performance or tenure with the company.
- It is also a motivational tool as owning a stock means having a partnership in the company and the success of the company would raise the value of the stocks.
- ESOPs is helpful in retaining employees.
Vesting schedule and ESOPs
A company provides A Brief Overview of Employee Stock Option Plan to its employees’ infractions & there is a vesting schedule for it. To exercise this option, an employee needs to wait for a certain duration is known as the vesting period which implies that the employee has to work for the organization until a part of the entire stock options could be exercised. For instance, an employee may get 3000 shares but that would be given to him/her in the sets of 1000 over a certain duration of time.
Failing to exercise this option of buying the shares within the vesting period, the options lapse and the employee becomes ineligible for any such rights. Nowadays many companies and startups have started following the trend of ESOPs to attract and retain skilled employees.
Benefits of Employee Stock Ownership Plan
General Benefits to employer
- To buy the shares of a departing owner:- Owners of private companies can make use of an ESOP to frame a ready market for their shares. Under this approach, Tax-deductible contributions to the ESOP are allowed to companies to buy out the shares.
- To borrow money at a lower after-tax cost:- ESOPs are unique among benefit plans enabling them to borrow money at a lower after-tax cost. The ESOP borrows cash, which it utilizes for purchasing company shares or shares of existing owners. The company then makes tax-deductible contributions to the ESOP to offset the loan, which implies that both principal and interest are deductible.
- For the creation of an additional employee benefit: A company can issue new or stored shares to an ESOP, cutting down their value (for up to 25% of covered pay) from taxable income. Or a company can contribute cash, purchasing shares from existing public or private owners. In public companies, which account for about 5% of the plans and about 40% of the plan participants, ESOPs are often used in correlation with employee savings plans. Instead of comparing the employee savings with cash, the company will match them with stock from an ESOP, usually at an elevated matching level.
Benefits to the employer In term of tax:
- Contributions of stock are subject to tax-deductible
- Monetary contributions are deductible
- Contributions utilized to offset a loan, the ESOP takes out to buy company shares are tax-deductible
- Sellers in a C corporation can obtain a tax deferral
- In S corporations, the proportion of ownership held by the ESOP is not subject to income tax at the federal level
- Dividends used to repay an ESOP loan are tax-deductible
- Employees pay zero tax on the contributions to the ESOP
Benefits of Employee Stock Ownership Plan for Employees
- Financial benefits in the form of higher pay, benefits, and wealth generation.
- Assurance of a comfortable retirement for employees.
- Employees’ responsibility towards their company elevates which motivates them to actively participate in company decision making.
- ESOP also provide non-monetary benefits, job security, and satisfaction to employees.
Working Procedure of ESOP
ESOP in India is administered by the Companies (Share Capital and Debenture) Rules, 2014. According to this Act, the employees can buy a certain number of company’s stocks from the employer at a price below the standard market rate.
ESOPs are prevalent among infant start-ups. From them, some of the steps to offering an ESOP are as follows:
- The first step is the drafting and submission of an ESOP scheme to shareholders for their approval. Prior June 5, 2015, the approval for this scheme needs to be obtained by a ‘special resolution’ and filed with the Registrar of Companies. But now private limited companies need not comply with this rule.
- After approval of the ESOP scheme in a shareholders meeting, the second step is an issuance of ‘Letter of Grant’ to the concerned employees. This letter contains important details about the number of options granted, the vesting period, the calculation of the exercise price, etc.
Note:- It is just the right to own shares but not shares.
- The last step is like the ball is in the employees’ court. Now after receiving ‘Letter of Grants’, an employee can opt for the ESOP option via the ‘Exercise Application’.
All the details given here have cleared out the ESOP and its definition for the basic understanding of an individual. ESOP has been used across the companies to divide the in house capital within the employees making the overall asset class structure to be much efficient and future prospective.
ESOP has been maintained by multiple companies to offer services in maintaining the overall ESOP offering and developing its structure for a smooth implementation of the ESOP scheme within the organization. Hence ESOP can be initiated across all the registered companies but have to analyze and thoroughly research as per the guidelines of the Sebi and other authoritative departments of India.