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What Is The Vesting Period Of An ESOP?

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March 30, 2023

Summary

What’s Inside

Has your employing company recently announced an Employee Stock Option Plan (ESOP) for its employees? In that case, it is a must for you to know what ESOP shares are, how ESOPs work and what the vesting period in ESOPs is.

In simple terms, an Employee Stock Option Plan (ESOP) is a scheme where an employer offers a portion of the company’s shares to the employees at preferential pricing. The stock options, however, cannot be exercised right away. They can only be exercised after the vesting period.

A Closer Look At Vesting Periods

The vesting period in an ESOP is the period from the date of issue of the ESOPs, after which employees with ESOPs gain access to the rights offered by their stock options. Typically, ESOPs have vesting periods of at least 1 year although they can go up to 5 years or more too. Let’s discuss an example to understand what the vesting period in ESOPs is more clearly.

Say your employer allocates ESOPs to you, giving you the right to purchase 100 shares in the company at a grant price of Rs. 50 after a vesting period of 3 years. At the end of this period, depending on the current market price of the company’s stocks, you can choose whether or not to exercise your ESOP. Check out the two scenarios below for more clarity.

Scenario 1: At the end of the vesting period, the company’s share price is ₹80

In this case, you have the right to purchase 100 shares at a much lower price of ₹50, thanks to your ESOPs. So, at the end of the vesting period, you can exercise your right and invest in the company at a relatively lower cost.

Scenario 2: At the end of the vesting period, the company’s share price is ₹25

In this case, the market price is lower than the grant price of ₹50. So, you can wait for the market price to increase beyond the grant price and then exercise your stock option.

Why Is The Vesting Period Important?

The vesting period in ESOPs is important for a number of reasons. Employees can only exercise their ESOPs if they still remain with the company till the vesting period ends. So, from the company’s perspective, the vesting period encourages the retention of talent within the company for a specific period of time.

The vesting period is also beneficial for employees in several ways. It allows them to remain invested in the stocks for a longer period, rather than simply exercising their right on the issue date itself. Furthermore, ESOPs, in general, foster a sense of ownership in the company and improve productivity by promoting a sense of belongingness.

Conclusion

In conclusion, understanding the vesting period in Employee Stock Option Plans (ESOPs) is crucial for employees who have been granted ESOP shares. The vesting period determines when employees gain access to the rights offered by their stock options. Typically ranging from 1 to 5 years, the vesting period encourages talent retention and provides employees with the opportunity to remain invested in the company's stocks. ESOPs not only offer a chance to purchase company shares at a preferential price but also foster a sense of ownership and enhance productivity among employees.

Frequently Asked Questions

What does a 3-year vesting period mean?

A 3-year vesting period in ESOPs implies that the employee can only exercise the rights attached to the ESOP after a period of 3 years from the date of issue.

Are ESOPs good for employees?

Yes, ESOPs can be extremely beneficial for the employees in a company. They allow employees to create wealth over the long term and promote a sense of ownership in the company.

Disclaimer

Fi Money is not a bank; it offers banking services through licensed partners and investment services through epiFi Wealth Pvt. Ltd. and its partners. This post is for information only and is not professional financial advice.
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