How to make the best of your ESOPs

What is an ESOP?

Employee Stock Option Plan, or ESOP, is a plan through which employers give their employees the option to purchase stock of the company at a lower or no additional cost at a specified time and specific price.

Thus, as the name suggests ESOP is an option to buy a share at a later date. The employer decides which employees to offer the ESOPs to, the timing, price and number of shares to be allotted to each employee.

Once an employee is given ESOPs, he/she has to hold on to them until the end of the vesting period. Once the vesting period is over the employee can exercise the option to buy the share of the company at the fixed price.

What to do with ESOPs?

Since an ESOP is a right to exercise the option to acquire a share of a company, the employee can choose if and when he/she wants to exercise the option.

Till the vesting date, the ESOP holder cannot take any action. On the vesting date these are the options available .

Do you require money for your personal needs?

 

If the answer is yes, you must exercise your option.

Do you wish to make a gain?

If your answer is yes, then you must get into the numbers. If the grant price/fixed price at which you can buy the share from the company is lower than the market price/fair market value, you can consider exercising the option.

Can you pay for exercising the option?

“When exercising your options, that is converting ESOPs into stock, it is understood that the exercise price has to be paid. However, most often the very important perquisite tax is forgotten about. So, not only must you be in a position to pay the exercise price but should also be able to pay the perquisite tax.," explained Sandeep Jethwani, Co-Founder Dezerv.

“In fact, in many cases, the perquisite tax amount is much more than the exercise price", Jethwani said.

Let the option lapse

If you don’t need the money or cannot arrange for the capital to exercise your option, you must let the option lapse.

Further, if the market price of the shares is lower than the exercise price, you can let the option lapse.

Company is getting listed

The buzz around ESOPs in an organization increases when the company is heading for an IPO.

So, what does one do if he/she holds ESOPs in a company that is going for an IPO?’

“When a company is about to go public, ESOP holders are faced with a choice of whether they should exercise these options before or after listing. There are two factors that one needs to consider before making this decision, first liquidity and second the view of the upside," added Jethwani.

If you require money for a financial goal, then you can consider exercising the option. However, remember that if one were to exercise the ESOP prior to listing, then the shares thus acquired need to be held for six months post listing. This directly impacts your liquidity.

On the other hand, ESOP exercised post listing can be sold almost immediately (subject to employee trading restrictions).

So why should one even consider converting prior to listing? That brings us to the second and most important aspect to consider when you hold ESOPs and the company is getting listed – the potential upside.

This is where your belief in the company as an employee will help you make a decision.

“As an employee of the company going in for an IPO, you have a unique perspective and understanding on the internal strength and inherent potential of the company," said Munish Randev, Founder and CEO of Cervin Family Office.

“This should help you evaluate how the company will perform in the long run," he added.

If you feel that the shares of the company will get listed at a premium and do well in the long term as well, you may opt to wait till the shares are listed, to find an opportune time to exercise your option and subsequently sell the shares at a profit.

“However, as an employee, you must remember that various factors impact how the stock of the company will perform after getting listed. And many factors are not in the control of the ESOP holder.

Hence, the sensible thing to do is exercise your option only when you intend to sell the shares acquired or need money for a financial goal or requirement," concluded Randev.