BackHow good are your Esops now?
How good are your Esops now?
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The slump in the equity market has not spared anyone. It used to be a steal to get shares of the company one worked in as an employee stock option plan, or Esop. These were usually offered at zero cost or were heavily discounted. They were an attractive deal till stock prices came crashing down. Many shares given in the last five years are at levels that are equal to or lower than the price at which they were granted, even if the offer price was half the prevailing market price. Above all, there is the job uncertainty.
To figure out what you should do with stock options, you first need to understand how Esops work.
Basic structure
Typically, a compensation package in the earlier days had a salary component and stock options. For example, a package of, say, Rs20 lakh consisted of a salary income of Rs10 lakh and Rs10 lakh as stock option. The latter reflected the value of the employee’s holdings after he got ownership of the shares by exercising his rights. So if an employee used the option and paid, say, Rs5 lakh at a time when the shares were worth Rs15 lakh as per the market price, the difference of Rs10 lakh was the employee’s benefit. Now, he could either hold on to the shares or sell them the next day.
All Esops are not structured the same way. The basic rules, however, remain the same as guidelines set by the market regulator have to be followed. A lot depends on the set of beneficiary employees. Says E. Balaji, director and CEO, Ma Foi Management Consultants Ltd: “IT companies tend to give Esops across the board, while non-IT companies limit it to the top management and critical roles" (read Building Blocks to understand how Esops work).
Whither now?
During the past few years, when the stock markets were on an upswing, the market price usually remained higher than the price at which you got the options. Many employees opted to take Esops and many didn’t. What should you do now? The answer depends on the present position of your stock options, job and finances.
• For those asked to leave: Even if an employee is asked to leave, the right to own the company’s shares holds. All unvested options expire on the date of leaving the firm but vested options can be retained. This, however, will also depend on how soon the vested options need to be exercised. Usually, it is within a specified period after resignation or termination.
•For those staying put: If you are relatively sure of your job, your approach towards stock options will depend on whether you have exercised all your grants in one go or in tranches.
•For users: With markets having fallen at least 50% since January 2008, the exercise price for many companies is higher than the current market price. Employees who exercised their options and sold the shares are better off in such cases. If they sold after holding for a year or more, they also avoided long-term capital gains tax. For those who are still holding on, the losses are higher.
•For non-users: Employees who are yet to exercise their option to own shares are confused. Says Balaji, “Finding money in the current economic situation to redeem shares, when most people also have other loans, is an added challenge. Also, increased concerns over employment security are not making the case motivating for employees."
Says N. Raja Sujith, partner at Bangalore-based legal firm, Majmudar and Co.: “If the employee doesn’t exercise his option during the period allotted, his right lapses."
To buy or not?
If you still have your stock options and the exercise period is ending soon but your finances don’t allow the purchase, there is a way out. Says Sujith: “You can either refrain from purchasing the vested shares or seek an extension of the exercise period which would be at the sole discretion of the company. See if your organization is ready to lower the exercise price. This will at least help you lower the average cost of holding. Alternatively, make your employer consider cash compensation in lieu of the loss incurred, which, again, would depend a lot on the agreement entered into."
If your options are already deep in red, let them go. Options issued at prices higher than the market price and not yet exercised will be cancelled. There is no penalty.
Shekhar Purohit, principal consultant, executive compensation and corporate governance, or APAC, Hewitt Associates Llc., suggests, “Chances are that Esops could be repriced to the current levels."
If Esop prices don’t get adjusted but you want to hold your organization’s equity, it would be better to buy from the market instead of purchasing through your Esop plan. This will also lower your average cost of holding. Sonu Iyer, partner, Ernst and Young Pvt. Ltd, feels it is important to see the financials of the company before one considers averaging.
Esops would still make sense if you have stock options whose exercise price is lower than the market price and, most importantly, your finances are in the black.
Let’s say you meet these conditions. The next step is to raise funds to use the Esops.
How to get the money?
• Company loan: Many companies help their employees with funds to buy stock options. Says Balaji: “Employees are usually given the option of paying for the value of shares later. As per the norms prescribed, this is considered a loan given to employees which is usually interest-free. Some companies allow the employee to avail such loans for an unlimited period till he re-signs or sells the shares, whichever is earlier."• Other sources: In some cases, employees were asked to exercise all options to avoid paying fringe benefit tax, or FBT. They did so through loans from banks. Now, servicing the loans is becoming difficult and stock prices have fallen. Says Balaji: “Try to get a soft loan from a relative or friend. Use this to pay back the bank loans. Else, banks may seek additional collateral to continue the loan. Of course, it is more important to ensure there are no threats on the job front."
Faced with these complex issues, many employees now realize that Esops are not as valuable as organizations made them look. So, new alternatives may come up in future. Says Iyer, “The focus is still on variable pays, but the ball is in the employer’s court to make them more effective." For most, it has been a lesson learnt the hard way that equity investment, either directly or at a discounted price through Esops, always comes with risk attached.
BUILDING BLOCKS: Essential elements of stock option plans
GRANT
The first step for offering Esops is usually a “grant" letter which informs an employee that he has been given “options" he can convert into shares. The employee has the right to convert the options into shares, but is not obliged to do so.
VESTING
The right to apply for shares gets activated at the end of the “vesting period", which can be a single time period or a series of time periods. As per norms, there has to be a minimum of one year between grant of options and vesting.
EXERCISE PRICE
This is the price at which the employee buys. Determined by the employer, it is usually lower than the prevailing market price
PAYMENT
When the vesting period is over, that is, when you pay for the shares, you have a few choices. You can pay your employer in cash to buy the shares or raise a loan. Once you have bought the shares, you can either hold them or sell immediately.
You can also decide not to exercise any of these options.
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