ESOP 101: What are the Benefits of Employee Share Option Plans?

Lakshya Singh, Anik Banerjee

Jan 24, 2022 — 8 min read

Running a company is always challenging, with all the tasks that need to be done. You need a motivated, loyal, and productive workforce to help maximize the company’s resources and output. However, motivating and retaining great employees can challenging, considering the salaries and other benefits that you have to provide them in exchange for their services. This is where an Employee Share Option Plan (ESOP) comes into play.

If this is the first time that you’ve heard of this concept, no worries. This article summarizes what ESOP is and how it can help business owners like you.

What is an Employee Share Option Plan?
Benefits of an Employee Share Option Plans for the Companies
ESOP Benefits to Employees
Company Share Option Plans and the Indian Companies
Takeaways
FAQs

What is an Employee Share Option Plan?

Simply put, an Employee Share Option Plan or ESOP is when a company offers its employees the option to buy a specific number of shares in the company, at a specified price that is typically lower than the market price, within a particular date.

In other words, this is an employee share option that allows employees to have an ownership interest in the company they’re working for. There are two types of share options that can be offered:

Incentive Stock Option (ISO) – This type of option allows an employee to get rid of taxes on the shares they own until the shares are sold. After getting the option grant, they will hold the stock for at least two years, and after a year of exercising the option, they can be eligible for a long-term 20% capital gains tax. This option is not transferable to anyone, even within the family.
Non-Qualified Stock Option (NSO) – This type of share option requires an employee to pay an income tax on the difference between the price at which you avail of the option and the grant price. Furthermore, the employer can agree if the employee wants to transfer the shares to the employee’s offspring.

Benefits of an Employee Share Option Plans for the Companies

With that general idea of what ESOP is, if you now want to know how an employee share option benefits your company, then the four (4) most common benefits of granting an Employee Share Option Plan to your workforce are summarized here:

Attract and Retain Talented Employees

Hiring and keeping talented employees is never easy and this is more of a truth in today’s world, where companies and startups abound. With the fierce competition in the business world, companies are competing with one another to get the staff they want for their company. Aside from attracting the best applicants, offering employee share option plans can also motivate workers to give their best, knowing that their output affects their shares.

Ideally, with an employee benefit plan such as ESOP in place, applicants will be attracted to join the company while current employees will be inspired to work and stay longer. Considering the fact that they have an ownership interest in the company, they will tend to be more loyal and committed to their job and for a longer period of time. As a result, your organization will be more productive and prosperous today and in the coming years as your employees work together in helping the company grow.

Boost Employee Morale

Having shares in the company in which they’re working can help boost the employees’ morale. Instead of seeing themselves as salaried personnel, they’ll feel like they’re owners of the organization and that they have a say over important aspects. They’ll become more inspired and committed to the best interests of the company considering that one of the benefits of availing of the ESOP is that they will get a share of the company’s profits in the form of dividends.

Cost-Effective

As mentioned, most companies are looking for ways to reduce the costs of employee benefits, searching for less-cost solutions that offer high value for their staff. This is how offering ESOP becomes an ideal addition to employee benefits.

Although these share option plans for employees are rarely considered as an alternative for compensation, they’re still a good part of your company’s benefits packages because they can make employment opportunities in your company more appealing.

Despite the lost chance to sell the shares at the best market price and the cost of executing the plan, you can still get the most out of this benefit option by keeping staff motivated and loyal to stay with the company.

If you’re a small business owner, administering ESOP can be a cost-effective way of competing with more prominent corporations in your area.

Offers Tax Advantages

Including employee share option plans in your employees’ benefits program comes with some tax benefits too for your business. Generally, not until they’re exercised, ESOPs are considered worthless on your company’s book of accounts. This means that you’re not required to list down these options pending as a cost.

Moreover, once the employees exercise their options, your organization is authorized to deduct a tax equivalent to the difference between the market price and the strike price (fixed price at which the owner can buy the shares) as compensation expense.

Some other advantages of ESOPs or employee stock ownership plans for the companies can be summed up as:

ESOPs helps boost productivity
They save companies from immediate cash outflow
They help ageing owners to exit from the company
ESOPs help reshuffle ownership
They enhance employee retention
They help companies attract new employees
They are excellent for startups and companies operating in a low to moderate budget
The employee share option schemes also helps increase the intrinsic value of the cmpany

ESOP Benefits to Employees

ESOPs certainly help the companies and startups grow in ways more than one but not without benefitting the employees. After all, it is centring the employees that the concept of ESOPs are built. According to the recent survey conducted towards the end of 2021, it has been discovered that the employees working with startups have made more than $335 mn solely with the help of employee stock option strategies.

Thus, ESOPs definitely help the employees to a great extent. So, let's have a glimpse into how the employee option plan for stocks prove to be a boon for the employees themselves:

ESOPs help enhances the job security of the employees
Startup ESOPs extend retirement benefits
ESOP in startups improves the employees' overall commitment to work
Share option plans make the employees wealthy
ESOP benefits the employees by boosting their professional growth

Company Share Option Plans and the Indian Companies

Company share option plans are growing more than ever all around the world. Therefore, the Indian markets are not an exception to it. The Indian ecosystem has seen around 44 companies turning unicorn in 2021. Acording to the reports dated December 2021, the Indian startups have raised a total of $39 Bn till the first week of December, which is an increase of around 225% from $11.8 Bn in 2020. All these fundings are also enabling a huge growth for the startup companies and an outstanding era of growth and innovation for the country as well. Along with the funding it usually boils down to the employees that companies have as far as growth is concerned. It is the talent that a company nurtures, which helps distinguish a great performing company to an average performing or a low-performing company. Here, implementing overwhelming employee stock option strategies comes in extremely handy to boost the employees. While the companies can certainly resort to giving cash bonus, freebies, week offs or gifts to their employees to motivate them, the ultimate motivation comes in with the administration of lucrative share option schemes as offers that the employees simply cannot refuse.

ESOPs are not only growing in numbers but also expanding in terms of the size. If you are now more curious to learn about the major Indian companies that have been promising decent employee stock options for the empoyees, then let's have a quick rundown along the best ESOP buybacks that the Indian companies has seen in 2021.

Well, Flipkart leads the Indian companies with the biggest ESOP buyback amount of $125 mn. The Walmart-led company has been succeeded by:

Browserstack - $50 mn
Swiggy - $40 mn
UpGrad - $29.5 mn
Zerodha - $27 mn
Udaan - $23 mn
Sharechat - $19 mn
Phonepe - $18 mn
CRED - $19.3 mn
Spinny - $12 mn
HealthifyMe - $12 mn
Unacademy - $10.5 mn
Chalo - $10 mn
Khatabook - $10 mn
Razorpay - $10 mn
Zetwerk - $8.3 mn
Urban Company - $7.3 mn
Simplilearn - $6.4 mn
Meesho - $5.5 mn

Takeaways

As you can see, ESOPs can be a perfect tool for businesses that are looking to attract the best talents, and for those who want their business to grow and succeed. For your convenience, this article summarizes information for you to know when you should consider ESOP for your business and more importantly, to convince people about the growth potential of your company.

FAQs

An Employee Share Option Plan is when a company offers its employees the option to buy a specific number of shares in the company, at a specified price that is typically lower than the market price, within a particular date.

What are the pros of offering employee stock options?

ESOP acts as a tool of motivation for the employees that once they own a stock they feel responsible for the performance of the company, as it determines the value of the stocks of the company.
It helps the employer to retain the company and assure a good level of performance in the work.

How do I avoid tax on ESOP?

To avoid paying taxes and potential penalties consider a rollover for your ESOP distribution. The rollover process takes place when tax-deferred funds from your ESOP are transferred to another tax deferred account such as an IRA or 401(k).

How ESOP is taxed?

The shares is short-term when held for less than 3 years and long-term when sold after 3 years. The period of holding begins from the exercise date up to the date of sale.