Apart from a monthly salary and other benefits, employers have started including other beneficial components in the salary package. One such powerful component offered by many modern employers, especially startups, is the Employee Stock Option Plan (ESOP).

SO, what is ESOP and what does it mean for you? Let’s understand in this guide.

What does ESOP mean and Why are ESOPs Offered to You?

An ESOP gives you the right to buy shares in the company you work for, usually at a price much lower than the market value. This isn’t an obligation; you are simply being granted the opportunity to own a piece of the business. It is a way for your employer to reward your contributions and make you a true stakeholder in its success.

The shares you are offered under an ESOP are often called stock options. You can purchase them at a pre-determined price, which could either be free or at a concessional price, depending on your company’s policy.

This approach is especially popular among startups. Instead of offering large salaries, which might not be feasible early on, startups use stock options to attract top talent and keep their team motivated. You gain potential future wealth, and your employer fosters loyalty and long-term commitment.

By giving you a stake in the company, ESOPs aim to ensure you feel invested in the company’s success, both professionally and financially.

How do ESOPs Work?

When your company offers you stock options, it does not mean you can buy the shares immediately. You have to work in the company for a certain period before you can own the shares, and the key term here is vesting.

Let us break it down further. Let’s say you received 1000 stock options from your company on 31 March 2021. You can’t buy all of them right away. Instead, they are split over a period:

  • After 1 Year: You can buy 20% (200 shares).
  • After 2 Years: You can buy 30% (300 shares).
  • After 3 Years: You can buy the remaining 50% (500 shares).

The vesting date is when each portion becomes available for purchase. The exercise price, i.e. the money you pay for purchasing each share, is decided on the day when the ESOP is granted to you.

How do Companies Benefit from ESOPs?

When employees are also shareholders, they are more motivated to contribute to the company’s growth. From an employer’s perspective, offering ESOPs leads to:

1. Lower upfront salary expenses
2. Increased employee retention
3. Improved productivity and engagement

Infosys, one of India’s top IT firms, was a pioneer in offering ESOPs to all employees, regardless of their rank. The result? Many junior staff members became millionaires as the company grew.

How do Your ESOPs Work in Practice: ESOP Example

Here is a simple example to show you how ESOPs work:

Imagine you are working for a particular company that rewards your performance by offering you an ESOP. The details are as follows:

1. Shares offered: 1000
2. Exercise price: Rs. 100 per share
3. Vesting period: 3 years

After three years, you will be eligible to buy 1000 shares at Rs. 100 each, regardless of the market price. So even if each share is worth Rs. 500 on the stock exchange, you will still pay just Rs. 100. That is a massive financial advantage.

Key Features of an ESOP You Should Know

Some key features of ESOPs are shared below: 

  • Cost-Effective: ESOPs are often part of your Cost to Company (CTC), and they come at no extra cost to you.
  • Two Key Dates: The day on which your company offers the ESOP is referred to as the grant date. The day on which you actually buy the shares is called the vesting date. 
  • Flexible Exercise: You can choose to buy all your shares at once or in stages.
  • Locked-in Price: You will pay the same exercise price, no matter how high the market price climbs.

What are the Benefits of ESOPs for Employees?

Now that you know what is an Employee Stock Option Plan, let’s focus more on its benefits: 

  1. Higher Returns

If your company grows, the value of your shares can skyrocket, allowing you to earn significant profits over time.

  1. Passive Income

Once you become a shareholder, you might receive dividends when the company earns profits. It is an easy way to grow your income without lifting a finger.

  1. Job Stability and Satisfaction

Being tied to the company through share ownership usually means better job security, at least during the vesting period. It gives you more job stability and satisfaction, which automatically reflects in your performance. Companies value this and may promote you to benefit from your long-term association. 

How are ESOPs Taxed?

You will encounter taxes at two stages:

1. When You Exercise Your Option
The difference between the Fair Market Value (FMV) of the shares on the date you exercise them and the exercise price is considered a taxable benefit. It is treated as perquisite and taxed under your normal income tax band.

2. When You Sell the Share

Once you sell your shares, the profit (selling price minus FMV) is subject to Capital Gains Tax (CGT). A couple of points to remember:

  • Your benefits are calculated using FMV and not the grant date. 
  • The day on which you took the option is considered the purchase date. 

Final Thoughts

ESOPs are a game-changer for both companies and employees. They allow employers to attract talent without blowing the budget, while giving you the chance to build wealth, gain financial literacy, and feel more connected to your workplace.

But to benefit from ESOPs, you will need a demat account to hold and manage your shares. Don’t worry, it is simple to get started! Open a demat account online with Share.Market and take your first step towards financial freedom. Here, you will also gain access to a world of investment insights designed to help you grow your wealth, and secure your future.

FAQs

1. What is an employee stock option plan (ESOP)?

An Employee Stock Option Plan means the benefits that an employee receives by purchasing the stocks of a company at a much lower rate than the market value.

2. What is the vesting period in ESOP?

After working for a particular company for a specific period, you can own the stock options granted to you. This is referred to as the vesting period.

3. How do ESOPs work?

The company provides the ESOP to its eligible employees at a price which is usually lower than the market value. The number of shares is also fixed on this date, also referred to as the grant date. Once an employee completes the required period to be eligible to exercise the stocks, they can buy the shares and realise the profit by selling them later.

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