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Been hearing about employee stock ownership plans (Esops) lately but don’t know what it actually is? Or have you been offered one by your organization and don’t know if you should exercise it? Whichever the case, this article will decode Esops. If you have been offered the right to exercise an Esop, it means the organization values your contribution. They wish to make your value addition go beyond your assigned tasks by making you direct custodians of the company’s long-term growth. Here are three important factors to consider before you sign up.

What is the grant price?

The main advantage of getting access to Esops is the potential discount between the grant price and the fair market value, at the time of exercising the Esop. The lower the grant price, the greater chance you have of making a profit when you exercise your option. In case of startups, the grant price may be at face value of the unlisted stock or as valued by a Sebi-registered merchant bank. For listed companies, the grant price is determined after considering the average stock price for a certain period before the issue date. 

What is the vesting and exercise schedule?

Your Esops have a vesting or lock-in period before you become eligible to exercise your option to purchase the stock. The Esop structure varies, depending on organizations and employee profile. You need to understand what the vesting and exercise rules are for the stocks offered to you. Say, company X offers 200 Esops on 1 April with a waiting period of one year and vesting period of four years staggered at 10%, 20%, 30% and 40%. The vesting schedule will look like this:

● Wait period till 31 March 2022

● 20 shares available on 1 April 2022

● 40 additional shares available on 1 April 2023

● 60 additional shares available on 1 April 2024

● 80 additional shares available on 1 April 2025

Most startups offer a 1+4 vesting period, which is treated as a minimum period to maximize the employee’s contribution in line with the value of Esops offered and to improve employee retention. The vested options could be exercised anytime till during their validity period (usually 10 years or more).

What are the exit options?

 If the employees leave the organization before the lock-in period, they lose their right to gain ownership at a discounted price. If you have vested a certain portion of the Esops, they will be held in the Esop trust and available for an exercise on maturity. However, the ones not vested will lapse.

Thus, the decision between forfeiting or exercising Esops should depend on the employee’s expectation of liquidity events like buyback or IPO in the future.

Esops come with an opportunity cost with respect to your earning potential and ability to meet long-term financial goals. While they can be very lucrative, you don’t compulsorily have to exercise your option. If you feel the fair market value is below your exercise price, or you have more lucrative investment options, you can forgo the right.

A financial adviser will be able to guide you regarding Esop suitability after considering your financial goals, as well as tell you if and when you should exercise the option.

Prateek Mehta is co-founder & chief business officer, Scripbox.

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