Employee stock option plan (ESOP) is a plan for employees in which employees are given ownership of the shares of the company or organisation they are working for. ESOP allows employees to buy shares of their company at fixed price. ESOP allows employees to have share of wealth of the company and infuses the sense of ownership and hence encourage employees to work more effectively and promote loyalty and trust amongst them.
ESOP acts as employee compensation policy and effective retention policy.
Stages of ESOP:
Grant Options: a grant option is a process by which an employee is given an option to acquire the shares of the company at a specified price
Vesting of Options: vesting is the process by which an employee receives the right to apply for and be issued shares of the company under the option granted. Until the vesting takes place, the employee does not have a right to apply for the shares
Exercise of Options: exercise of an option means that the employee applies to the company for the issue of shares against options that have vested. An option merely sets up the machinery for creating the benefits to the employees. The benefit accrues on its exercise
Lock-In Period: Also known as the vesting period. Employees can only exercise his rights after this period is over. If the employee leaves the organization before this period their ESOP gets lapsed and they will not get any benefit.
Exercise Price: The price offered to the employees to buy the shares, it is usually below the current market price.
Benefits of ESOP:
Employee stock options have many benefits both for the employees as well as the employers.
Employee Retention: ESOP can be exercised only after the lock-in period or else the ESOP gets lapsed. Therefore an employee stays in the same organization for a long period of time hence it benefits the company.
Ownership of the Employees: The sense of ownership (shareholder) which the employee gets through ESOP motivates them to give their best. As a shareholder the employees get to share the profit and loss of the company hence they work to their full potential which is beneficial for both the parties.
Taxation on ESOP:
TDS- ESOP is considered as salary hence TDS is deducted on it.
Capital Gain Tax- The profit earned by selling ESOP is considered as capital hence capital gain tax is charged.
An employee stock option is commonly viewed as a complex call option on the common stock of a company, granted by the company to an employee as part of the employee's remuneration package.
The grant is not a taxable event. The bargain element of a non-qualified stock option is considered compensation and is taxed at ordinary income tax rates.
The company is required to issue new shares of stock when employees exercise their options. This increases the number of shares outstanding and dilutes the value of stock held by other investors. To forestall the dilution of value, the company has to either increase its earnings or repurchase stock on the open market.
Many companies use employee stock options plans to compensate, retain, and attract employees. These plans are contracts between a company and its employees that give employees the right to buy a specific number of the company's shares at a fixed price within a certain period of time.
Employers can offer company stock options to employees, including those in managerial and rank-and-file positions. Stock options, which represent equity ownership in a business, enable employees to purchase stocks at a predetermined price over a present number of years.
Whether to negotiate for more stock options or more money when taking a new job. If you do choose to buy or exercise your options, you may pay less than the market price to own shares in a growing company. If the company does well, you may be able to sell your shares at a profit.
Exercise your stock options to buy shares of your company stock, then sell just enough of the company shares (at the same time) to cover the stock option cost, taxes, and brokerage commissions and fees. The proceeds you receive from an exercise-and-sell-to-cover transaction will be shares of stock.
When you exercise a call option, you would buy the underlying shares at the specified strike price before expiration. You would exercise your rights and buy the shares only if the call option is in the money, meaning the strike price is less than the stock price.