In this age of competitive corporate, business companies are looking for fresher and fresher methods of luring talented employees and holding them. One powerful tool that most Indian companies use is the Employee Stock Ownership Plan, or ESOP. But what is ESOP and employee stock ownership, and how do they get an employee wealthy? This article will discuss in a lot of detail ESOPs, how they work, the benefits they hold, and the means by which they help workers accumulate wealth over time.
Find what is ESOP and employee stock ownership
Employee Stock Ownership Plans (ESOP) are schemes in which the employees are given ownership interest in the firm. The most significant thing about an ESOP is that it provides employees with the feel of being part of the firm’s success by giving them company shares either at a reduced cost or as a reward.
ESOPs have gained high acceptance in India from entrepreneurs and companies. SEBI has provided guidelines to monitor employee stock options as a step to protect the interest of the company as well as the employee. The strength of Employee Stock Ownership Plans is the interest of the employee being linked to the shareholder’s interest. Employees are more motivated, efficient, and devoted when they are owners.
How ESOPs work
Typically, the companies initiate ESOPs with a prior plan for option grant date, vesting period, and exercise price.
Option grant date
The company issues options to the employees on this date.
Vesting period
Time frame for which the employees must stay within the company before they have absolute ownership of the shares.
Exercise price
The amount on which the shares are being provided to the employees from and after the vesting date.
For example, an employee is granted 1,000 options at Rs. 100 per share which vests after four years. After four years, if the shares of the company are traded at Rs. 300, then the employee can buy the shares at Rs. 100 and sell them at the market rate, making a huge profit.
Types of ESOPs
Essentially two types of stock options plans are common in India:
1. Stock option to be taxed
Income so derived by exercise of such stock options is taxed as perquisites of the income tax act at the time of exercising of option.
2. Employee stock purchase plans (ESPP)
These allow employees to purchase shares at discounted prices without vesting waiting periods. These are subject to capital gains tax on disposal.
One should consider the taxation. For example, currently until 2024, ESOP profits in India are categorized as perquisite income and are under salary income and get taxed at the slab rate of the individual.
How ESOPs accumulate employee wealth
ESOPs are not merely a question of being an owner; they are a highly worthwhile method of wealth accumulation in the long term. This is how:
1. Appreciation of capital
As the value of the company increases, its share price also appreciates. Employees owning shares under ESOPs directly gain from capital appreciation through converting share options into actual gains.
2. Income from dividends
In addition to capital gain, stock-owning employees also receive dividends paid by the firm, another source of income.
3. Long-term retirement saving
For most workers, ESOPs are a long-term savings that is their work in duration. After the shares vest and mature, they can cash out the proceeds as retirement money or invest in substitutes.
4. Tax-effective investment
Even though ESOP benefits are tax deductible, through smart planning, post-tax returns could be maximized. Holding shares in excess of 24 months makes the gains long-term capital gain tax at a concessional rate of 20% indexed so that employees can be rich with less effort.
ESOPs and employee motivation
Employee stock ownership does more than making money in monetary terms. It gives a sense of belongingness and ownership. The employees do feel that they belong to the corporate quest and are willing to work in a positive direction for its growth. Lower staff turnover and retention of best brains is a direct result of this sense of shared ownership.
Challenges and problems with ESOPs in India
Despite their benefits, ESOPs have some drawbacks to keep in mind for businesses and employees:
Valuation challenge
For non-public companies, it is not always simple to establish what the fair market value of stocks is.
Lack of liquidity
When comparing ESOP stock for non-public companies to stock that may be bought on the open market, there may not be sufficient liquidity.
Taxation complexity
As above, the time and mode of exercising the option can determine if it is taxed or not.
Market risk
The stock prices can fluctuate hugely, and the workers’ wealth depends on the luck of the company.
The firms need to inform employees about such things so that proper decisions are taken and economic planning is done.
Increased popularity of ESOPs among Indian startups
With the Indian startup revolution, ESOPs have emerged as the most popular compensation vehicle. Indian unicorns such as Flipkart, Zomato, and Byju’s use ESOPs heavily to compensate early employees as well as retain talent. Government of India efforts towards making ESOP taxation easier have also given a boost to large-scale adoption.
How to maximize ESOP benefits
For maximizing Employee Stock Option Plans (ESOPs), employees should have a pre-researched and well-planned strategy. These are the necessary steps towards maximizing value:
Know your vesting schedule
Mark down the date when your options vest and exercise date so that you won’t miss it.
Monitor company performance
Observe company stock price changes and company valuations so that you exercise at the right time.
Save for taxes
Remit tax obligations upon option exercise and stock sale prior to unexpected draws.
Diversify the portfolio
Don’t put all your eggs in one basket—spread ESOP money into other investments.
Ask the experts
A planner will help you align your ESOP plan with long-term money requirements and retirement requirements.
Successful ESOP planning can yield wonderful long-term money advantages.
