Employee Stock Option Plan (ESOP)

ESOP Glossary Terms
Grant date – The date on which employer enters into an agreement with the employee and
offers them company shares to buy at a future date.

Vesting date – The date on which employee agrees to purchase the shares of the company by
accepting the specified terms & conditions.

Vesting period – Vesting period is the difference between the grant date and the vesting date

Exercise period – Exercise period is the period when an employee is eligible to buy the shares
after being vested.

Exercise date – The date on which employee exercise the option is known as exercise date.

Exercise Price – The price at which the employee may exercise the option is known as Exercise
price. Exercise price is usually lower than the existing fair market value of the share.


Who Is Entitled To ESOP?

The employees of the company are entitled to the ESOP but company specified certain criteria to make
employees eligible for it. ESOP scheme can be claimed by –

 Permanent employees of the company working inside or outside India.
 A part time or full time director of the company
 An employee working in a holding, subsidiary or associate company within or outside India.

How An ESOP Works??

In the first step, company formulates a plan for ESOP scheme and gets the approval for the same
from the shareholder’s in a shareholder’s meeting. Previously, this scheme was filed with the ROC
after getting approval by passing a special resolution but from 5th June 2015 onwards, private
limited companies (https://www.finacbooks.com/private-limited-company-registration-online) rule
has been changed and they don’t have to comply with the same.

After getting approval in a shareholder’s meeting for ESOP scheme, “a letter of grant” must be issued
to all the eligible employees. The letter of grant should contain the information about the following –

1 Number of options granted
2 Calculation of the exercise price
3 Vesting period
In the third step, employee of the company should make an “exercise application” if he wishes to
exercise the option granted to him. After making an exercise application, his options will be easily
converted into equity.


Benefits Of Employee Stock Option Plan (ESOP)

Employee stock option plan offers benefits to the company as well as to employees who choose to exercise
the option.


Benefits Of ESOP For Company

 It motivates the employees and creates ownership interest in them to work together for a common goal
i.e. company growth.
 Employees become more loyal towards the company.
 The brainstorming sessions are conducted to find new techniques to increase company’s productivity.
 Employees work in unity to reduce the wastage in the organization
 It increases the trust factor of the working employee in the management and company too.
Due to highly motivated workforce, employees try to achieve more & more to increase the company’s
share value.

Benefits Of ESOP For Employees ESOP oers several benets to employees –

Employee stock option plan brings various financial benefits to the employees of the company
such as higher pay, overall wealth generation, other benefits etc.

Employees feel more responsible towards the organization by holding the shares of the company.

They also participate in the decision making process of the organization which make their attitude
more positive towards the organization in future.

After getting both monetary & non-monetary benefits from the organization. Employees feel
more satisfied and more secured in job. Therefore, ESOP helps in satisfying the employees too.


Tax Implications Of ESOP

 Options provided by the company are not taxable

 Vested options are not taxable

 Company offers shares to employees at a less price in comparison to fair market value price. The
price at which the employee may exercise the option is known as exercise price.

 When employee exercises the option of buying shares, the tax will be imposed on the employees as
per the tax bracket based on the difference between the market value of the shares & exercise value of the shares.

 If the employee sells its shares after increase in the price of share, it is considered as capital gains
whereas loss in selling the shares is known as capital loss. If an employee sells the shares within 1
year, 15% tax is levied against the capital gain but if employee sells the shares after 1 year, he will
not be taxable and they are considered as long term assets.

 If an employee is working in a company based in abroad and having employee stock option plan too,
the shares sold by the employee and the amount received will be considered as short term capital
gain & will be added to the income of the employee. The employee will be taxed, if it falls into the
income tax brackets (whichever may be)

 If there are long term capital gains –

1 20% of tax levied with the benefit of indexation.
2 10% of tax levied without the benefit of indexation.

Disadvantages Of Employee Stock Option Plan (ESOP)

1 The liquidity benefits with ESOP’S is highly uncertain

2 The company’s only hope for compensation is indirectly through increased liquidity and through tax
advantage sometimes. Therefore, the risk for exercise remains for the same and this can make options
riskier than normal stocks.

3 There are still many unclear guidelines for valuation & accounting procedures of employee stock option
plans (ESOP’S) in a company.