Numerous organizations use employee stock options plans to compensate, retain, and attract workers. These plans are contracts amid a corporation and its employees that give employees the right to buy a specific number of the corporation’s shares at a fixed price within a certain period of time. The fixed price is regularly called the grant or exercise price. Employees who are granted stock options hope to benefit by exercising their options to buy shares at the exercise price when the shares are trading at a price that is higher than the exercise price.
Significance of ESOP for Companies
It is an effective scheme for corporations, particularly start-ups, that would take some time to break-even and is normally not in the position of offering large remuneration packages to their employees.
Offering an ESOP acts as an incentive for employees towards investing in the corporation’s growth.
It creates a sense of ownership in the employee for the corporation, encouraging greater productivity.
A corporation that allows its employees towards buying ESOPs on a future date at pre-determined prices, garners a long-term commitment towards the company from the employees.
Who is entitled to ESOP?
Basically, the employees of a corporation are entitled to the Employee Stock Option Plan (ESOP) but the corporation sets specific criteria to make employees eligible for the same. Benefits under the ESOP scheme could be claimed by-
A permanent employee of the corporation working in or outside India.
A part-time or whole-time director of the corporation.
An employee of holding, subsidiary or associate corporation, whether in India or outside India.
Promoters of Directors of the corporation holding above 10 % of its equity cannot take part in an ESOP.
It is essential to comprehend the following terms related to ESOPs-
- Grant- The grant of an ESOP refers to the commitment made by the employer through issuing the ‘Letter of Grant’ informing concerned employees about their eligibility to avail benefits under the scheme.
- Vesting- It means the right to own shares in his company over a period of time. The rights over these shares are non-forfeitable.
- Exercise-The corporation, initially, grants an Option. If an employee decides to convert this option into shares, it is called ‘exercising’ the option.
- Exercise Price- Also recognized as Strike Price, this is the price at which these shares are offered towards the employees. It is generally below the current market price and is pre-determined. The employee has to pay the strike price and purchase the respective shares.
- Exercise Period- After the vesting period, the employees are given some time for exercising the options granted towards them. This is recognized as ‘Exercise Period’.
Employee Stock Option Plan for Startup:
Employee Stock Option Plan is a great tool to align the objectives of new prospective employees with the corporation shareholders i.e. Growth of the corporation. Early-phase startups are quite often at a dearth of resources and the prospect of future resources could act as not only a retention tool but also as an attraction tool for future employees.
What Are Stock Options For?
Stock options are granted towards employees for 3 main reasons:
Compensation: Startups could not usually afford to pay lucrative salaries to highly skilled employees. To make up for this, corporations offer stock options to decrease the spread between the cash salary and the full market salary.
Align incentives: Employees have a propensity to work harder for investors when their motives are better aligned.
Retainment: Stock options would generally vest for multiple years. During this time frame, turnover must be lower because employees are persuaded to stay with the corporation until they're able to exercise the options. Stock options permit businesses to compensate and attract skilled employees by tempting them with lucrative paydays.
What Are Stock Option Plans?
Employee stock options permit employees towards taking part in the corporation’s success without requiring the corporation to expend precious capital during the startup procedure. In fact, employees are generally required to pay the exercise price for the options, which assists to contribute to the company's capital.
The most significant detriment of stock options for a business is that it might cause a dilution in the other stockholders' equity after the options have been exercised. For employees, the main disadvantage is that if they work for a private corporation, there might be a lack of liquidity when they want to sell the option.
Prior to going public, the options would not be equal to cash because there's no market to actually sell the options. If the corporation doesn't grow, the options might become worthless over time. Stock options are appealing to employees on the grounds so many individuals have become millionaires through the use of them, and businesses like to utilize them because it keeps their employees motivated.
The benefits of ESOPs for Startups:
Employee Attraction and Retention- ESOP is a way to engage a sense of ownership in the employees. This additionally motivates the employees to stay connected with the corporation for longer durations. The early phases of startup require retaining and motivating employees to work hard and accelerate the growth of the corporation. ESOP ensures to the employees that they are also a part of the profits and revenue the corporation is generating.
Motivational Push- As an employee starts working for the corporation and sees the development of the corporation they start to realize the further the corporation progresses, the more the value of their individual shares. This often offers as a way of motivating the employees to start putting in extra hard work and going the extra mile to make sure the corporation’s share value rises as does their own personal share value.
Cost Control – Corporations offer ESOPs as compensation for cash rewards and bonuses. Early-phase start-ups are generally not in a good financial position to afford highly competitive salaries. Though, offering ESOP fulfills the promise of providing exciting pay for the employees without compromising present cash supply and financial resources. This leads to effectual cost control in the present scenario where every penny matters.
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