What better way to get your employees invested in your company's growth potential than by handing them an ownership stake? That’s the beauty of Employee Stock Options (ESOPs) - a way for employees to acquire shares of a startup at a lower price.
Employees with ESOPs hold an equity stake in the company, allowing them to feel more invested in its growth. This in turn leads to improved productivity and stronger loyalty to the company.
In turn, companies will typically offer ESOPs to early-stage employees, forming the initial team and other core members or, later, to employees considered ‘higher value’. thereby reducing their chances of being laid off. However, this can be both an advantage and disadvantage as you’ll read further on.
You see, we’ve discussed ESOPs multiple times on our blog, including a discussion about if ESOPs are the right for employees, but it’s now time to go beyond and ask:
ESOPs work out only if the share price increases.
Any gains from ESOPs - whether converted into shares or cashed out - result in the employee having to pay a capital gains tax. Sometimes, the share price barely increases - this combined with the tax can make the total gain negligible.
Companies often put ESOPs as part of the offer - instead of a competitive salary matching the market value. During periods of recession, like in the pandemic, some companies like Oyo and Zomato even cut employee salaries with the offer of ESOPs.
You should be paid your worth instead of shares that could only potentially be worth something.
You cannot sell these shares easily - meaning they have zero value unless you get an exit option. You can cash out on your ESOP three ways: when the company goes public, buyout by an external investor, or buyback. When you take into consideration the difficulty of the Indian startup space, none of these options is an easy exit.
Vesting means that your ESOPs are earned over a period of time and the possibility of immediate cash-out is pretty much non-existent. Some vesting periods are month-to-month while other companies mostly offer a yearly option. This period is typically laid across 1-5 year periods. If an employee resigns or is fired before the vesting period ends, a huge portion of their ESOPs could be lost.
The company’s ESOP pool is to be considered when shopping the business around. Raising equity and investment is harder when the balance sheet includes for ESOPs, since they’re a long-term financial burden on the company.
ESOPs are mostly good for the company because the ‘good’ comes with a fair bit of risk. The pros for the company include being to attract employees aligned with the company vision who are more loyal and reduced short-term expenses in the form of lower salaries offered. However, they’re a long-term investment, meaning the risk can be higher when it comes to procuring investment.
The only risk an employee will have concering ESOPs is the possibility of little to no return. There’s only so much a salary can create in terms of benefits - but ESOPs can make the employee feel invested in the company’s growth vision. Unfortunately, there’s a lack of good exit options, difficulty in cashing out, and a vesting period that is long.
Now that you know more about the good and the bad of ESOPs, you can make a more informed decision about whether or not to exercise your stock options after the vesting period. Furthermore, as an employee having a salary account can also benefit you. Fi Money, in partnership with Federal Bank, offers a feature-rich salary account tha comes with a 0 balance savings account, a free VISA debit card, 0 forex charges and benefits worth ₹30,000 every year!
Employees given an ownership stake in the company tend to feel more invested in the company’s success. This directly translates into an increase in motivation and productivity, resulting in a boost in morale. However, employees should understand the risks involved with ESOPs.
There are a lot of administrative costs involved in managing ESOPs, and that reduced flexibility also comes from the need to comply with SEBI and regulatory requirements. The company will also need to file reports with the Income Tax Department, SEBI, and the Registrar of Companies with information about the ESOP plan, including details about the vesting period.
Yes, it can create conflict, given that employees would prioritise an increase in share price over the company’s overall well-being. The first is more short-term as opposed to the company’s long-term vision.
While it would be best for companies to get the advice of experts before creating an ESOP pool, an STT (securities transaction tax) will be applied when employees exercise their share options. This and the burden of capital gains tax when these ESOP shares are sold. There would also be a tax on the potential value of ESOPs offered as non-monetary compensation.
ESOPs depend on the financial state of the company. Yes, it’s a great way to attract phenomenal talent and boost performance. But the administration costs are expensive and a financial burden on the company. It depends on the company.
A fair amount of risk is involved in an Employee Stock Purchase Plan (ESPP), which is different from ESOPs. ESPP allows employees to purchase shares at a discounted price. There’s also no vesting period, so employees can hold or sell immediately. The risks depend on the stock market. When the employee decides to sell their shares, having to pay tax on capital gains. There's another issue if the employee tries to stay safe with a lack of portfolio diversification, putting all bets on their company's shares.