ESOPs - The Must-Know Terms For Every Founder
Employee Stock Options Plan
Introduction

As per the recent reports on the Indian startup ecosystem, startups are mushrooming at an annual growth rate of 10-12%. This demands well-organized planning of resources, right from getting the right tools and assets to putting together a robust team in place.

The aggressive competition in the startup fraternity makes onboarding employees and retaining them very crucial. And that is only feasible by rewarding them for their immense contributions. One such reward that startups give out in the current scenario is Employee Stock Options Plan (ESOP).

Understanding ESOPs

Generally, startups roll out this scheme for selected employees based on their ability and position to impact the organization. ESOPs allow employees to buy the organization's shares at a markdown price.

Usually, this is a part of the retirement and employee benefit plan, giving employees ownership of interest. This ownership comes in company shares, assured upon fulfilling predefined conditions. But more often, ESOPs become a part of startup compensation offerings to motivate employees to give their best at work.

As we know that much is involved in the structure and operation of the ESOP. This article aims to let founders and CHROs know the basic ESOP terminology to plan and execute the ESOP smoothly.

Let's Navigate The Terms Related To ESOP That You Must Be Aware Of

1 ESOP Pool

The portion of the company's shares allocated to the ESOP is called the ESOP pool. Usually, it can be 10-15%, but the percentage of early-stage startups can be below. Therefore, companies need to be careful when separating their capital.

2 Stock Options

Stock options give the purchaser the right to acquire the company's shares at a specified price later without obligation. This means that employees can get a significant discount when purchasing the employer's stock through the employee participation plan.

3 Vesting

Vesting is the gestation period from the employee's hire date to when the ESOP is available for purchase. The vesting period protects the employer by ensuring that the employee receiving the ESOP is obligated to the company. In India, the statutory minimum contract period is one year. This early-stage, also known as the cliff period, allows employees to begin vesting. At the end of the cliff period, no transmissions will occur.

4 Stock Appreciation Rights (SAR)

Stock Appreciation Rights provide employees with the same economic benefits as ESOP but different functions. Instead of the right to purchase a particular share of the company, the employee is granted an amount equal to the increase in the company's value over a specific period (that is, the variance between the strike price and the market price on the vesting date). Either cash or stock offsets this increase in value.

5 Restricted Stock Unit (RSU)

Restricted Stock Units (RSU) are organization shares granted directly to employees with restrictions. RSU plans will typically have vesting periods, giving employees shares over time or when defined milestones are met. RSU plans don't have an exercise price since the workers are granted shares directly.

6 Phantom Shares

Phantom Shares are typically a contractual agreement between the organization and recipients that grants employees the authority to cash equivalent to the value of a set amount of shares. This promises a financial reward to workers that are tied to the value of the organization's shares without bestowing them actual ownership over organization shares. As such, phantom stocks function closer to a contractual advantage than equity

7 Exercise

Exercising is when employees purchase shares based on their ESOPs. Employees can buy vested stock options from the company at a predefined price decided at the time of grant, called exercise price.

    


  • Exercise period: The period during which employees can exercise their ESOPs and purchase shares, after which the options will lapse.
  • Exercise date: The date on which an individual employee chooses to exercise their option.
  • Spread: The difference between the fair market value of a share on the exercise date and the strike price is the spread or discount. This is essential to calculate the excise tax, which determines the employee's tax liability on exercising options.

Wrapping Up

ESOP terminology can be confusing and overwhelming to some extent. And for that, Vega Equity is here to simplify your work, streamline your policy and seamlessly execute the transactions on time. Get in touch with us to know how we can help.

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