ESOPs, or Employee Stock Option Plans, have gained attention with success stories like Freshworks, where employees became millionaires overnight. Understanding ESOPs lets you get insights into this employee benefits program. Let's dive into the world of ESOPs, starting with what they are and their significance in startups and small businesses.
The Employee Stock Option Plan (also referred to as the Employee Stock Ownership Plan) is an employee benefit program that allows you to buy your company's shares at a highly discounted rate. In other cases, the employee might give away the shares for free instead of cash rewards or as a performance-based or retention incentive.
It is far more likely to happen in a startup environment or fledgling small and medium businesses. It is because these enterprises are at the stage of their lifecycle when they have a limited amount of cash to spare. Hence, ESOPs become a big part of the compensation package to attract talent. The ESOP terms and conditions are designed to encourage employee loyalty, commitment, and productivity.
There is no fixed set of rules when it comes to the ESOP. In other words, each organisation can follow different ESOP terms and conditions, and there is a certain leeway in implementing and executing the policy. However, they have an umbrella of regulations to ensure fair trade practices formulated by regulatory bodies like the Securities and Exchange Board of India (SEBI).
But in actual administration, SEBI is only responsible for companies listed on the Indian stock exchanges. For unlisted startups and other SMBs, the Companies (Share Capital and Debenture) Rules, 2014 sets and monitors the guidelines.
Before we proceed, let's familiarise ourselves with key ESOP terms for better comprehension:
*Granting: When the employer issues stocks to employees.
*Vesting: The process of employees applying for the granted shares.
*Exercising: Converting vested rights into stock ownership, with the option to hold or sell. Exercise occurs after the lock-in period, and the employee buys shares at a predetermined price.
*Eligibility: ESOPs are exclusively for permanent employees, directors (with less than 10% shareholding), and subsidiary employees. Freelancers and contractual workers are not eligible.
*Issuance: ESOPs can be issued through equity shares upon exercise or through an employer-created trust acting as an intermediary.
*Lock-in period: A minimum one-year period between grant and vesting, with companies setting longer durations. During this time, employees can only earn dividends or vote once they exercise their options.
*Transferability: ESOP shares cannot be transferred. If an employee resigns, vesting rights remain until the prescribed period. In cases of termination for misconduct or death, ESOPs can be forfeited.
Here's all you need to know about tax implications on ESOPs.
When the option to buy the shares from the employer is exercised, the ESOP gets treated as a perquisite ( a perk that is part of the salary). Hence, it becomes mandatory for the employer to deduct tax at source (TDS) and furnish the details under Form 16.
It attracts capital gains tax on the profits made in the sale. If you have held the shares for over one year, then long-term capital gains tax (LTCG) is levied. If the shares were sold off before 12 months from the date of purchase, you would incur short-term capital gains tax (STCG).
While ESOP Scheme Disclosures may be referred to in many ways, it governs your employer's process. It is a must-read document before you accept ESOP in any form. Ideally, the employer needs to categorically disclose all the pertinent information, including (but not limited to):
ESOPs offer a unique opportunity for employees to participate in the success of their company. Understanding the terms and conditions is crucial with eligibility criteria, vesting periods, exercise prices, and more. Valuation mechanisms, tax implications, and disclosure requirements further shape the ESOP landscape. By carefully reviewing and considering these factors, employees can leverage the benefits of ESOPs.
As per the guidelines by SEBI, there needs to be a minimum of one-year lock-in between the grant of options (i.e. issuance of the ESOP) and the option's vesting. The employer can set their own lock-in for exercising the option.
Employees are awarded rights under the ESOP terms and conditions to safeguard their interests. Some prominent ones include full disclosure by the employer regarding the ESOP plan, calculation formulae, and accounting policies.
There's no standard timeline for ESOP exercise. It can be anywhere from a few months to a few years.
Exercising ESOP means that, as an employee, you choose to buy company stock at a predetermined price after a vesting period. It allows the employee to benefit from potential company stock price gains. You can then keep or sell the shares.