What is ESOP? Decoding ESOP and its Components
employee stock option plan
What is ESOP?

As evident from the nomenclature ESOP is an Employee Stock Options Plan. ESOP can also be classified as a Reward for an Employee in form of his/her participation with the company in the form of Equity Shares of the company wherein they get the opportunity to grow along with the company and the company’s and employee’s growth can be visibly linked. The wealth which gets created from the hardcore efforts of the employees gets rewarded/distributed to employees in form of ESOPs.

When the Company and the Employees both have the same interests and goals it results in better results with fewer organizational conflicts. In other words, we can also say that ESOPs allow the Employees to be part owners of the organization after the vested options get exercised and converted to shares of the Company.

ESOPs are also used as a tool to motivate and reward employees for their loyalty and efforts towards organizational success. This is one of the best methods to motivate and retain the best resources/talent in the company for both long-term and short-term goals.


Understanding ESOPs Terminologies

ESOPs are granted to employees of the organization with the predetermined vesting period, exercise price, and other conditions as per the Company’s ESOP Plan.

We can get a better understanding of the ESOP from an Organization point of view with the below explanations.

Options Granted – The number of Stock Options granted by the company to the employee.

Vesting Schedule – This determines the Vesting period (period over which the employee will become entitled to exercise the options into shares) for the Options Granted. In India there is a Cliff of 1 year in the vesting period i.e., the 1st Vesting of the options will happen only after the end of 1 year from the Grant Date. We will explain the Vesting Schedules and conditions separately in our future blogs.

Exercise – This is the event when the Employee can convert their Vested Options into actual Equity Shares by paying an exercise price (as per the Grant Letter) within the predefined Exercise Period.

Exercise Price - This is the discounted price that an Employee needs to pay at the time of exercising his rights or converting his options into equity shares of the company. The exercise price of the options is determined at the time of the options grant.

Sale of Shares – Please note that only the equity shares can be sold for liquidity purposes and not the ESOPs or Stock Options. Employees can sell their equity shares at the prevailing market price and monetize them. For listed companies, there is always a ready market or ESOP.

Trust to buy the shares but for unlisted companies or startups, the same can be liquidated at the time of further funding event or Secondary transactions or buyback by the company of the options granted.

We hope we were able to give you a basic understanding of what ESOP is. If you’re looking for more information on ESOPs and their structure keep following our posts or schedule a demo with us.

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