ESOP Terms : A term that all founders need to know

ESOP Terms : A term that all founders need to know

The Employee Stock Ownership Plan (ESOP) is a new way to reward employees. They like to save money but are great for startups that often pay their employees.

That said, much is involved in the structure and operation of the ESOP. Therefore, the founder needs to know the basic ESOP terminology to smoothly plan and execute the ESOP.

We've made this task easier by creating a cheat sheet for this ESOP term that you can review at any time. The founder of the ESOP term needs to know.

In India, ESOP is regulated by the Companies Act 2013 and Regulation 2021 of the Indian Securities and Exchange Commission (Equity-based Employee Benefits and Sweat Equity). Companies can set up ESOPs either directly or through a trust.

By the Companies Act 2013, the ESOP is defined as an option that gives directors, employees, and officers of a company or its holding company or subsidiary the right to pre-purchase, use or subscribe to its shares at a fixed price in the future. 

Basic ESOP Terminology

You need to know these ESOP terms:

Stock option

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

Schema document

A document outlining all the conditions of the ESOP, specifically eligibility, the percentages that can be exercised at each stage, and the strike price, is called a planning document.

ESOP pool

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

Three levels of ESOP terms

The ESOP terminology is divided into three segments based on the various phases of the ESOP, as described below.

Grants

The first layer is granted when employees are given options. The main ESOP conditions at this stage are:

Grant Date: The date the company grants the ESOP to the employee.

Exercise Price: Also known as the Exercise Price or Grant Price, it is a discounted price that allows employees to purchase shares in the company after the lockup period has expired.

Expiration Date: The last date an employee can exercise an option. After that, it will expire.

This information must be included on the approval form.

Vesting

Vesting is the gestation period from the employee's hire date to the date 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 at once. Distributions are organized according to the type of vesting, as described below.

Hour-based vesting

After the first cliff period, employees can vest a certain percentage of the total number of options entitled each year. In some cases, this is further divided into quarters or months over time.

Project-based vesting Instead of time as a determinant of approval, completing a particular project is considered a milestone in which approval for the employee to exercise the option occurs.

Hybrid Exercise

It combines time and project-based vesting to combine the best of both worlds.

Accelerated vesting

This is known as preferred vesting if the company allows employees to exercise their options before the agreed vesting schedule (based on the three types above). This usually happens during a merger or acquisition.

The number of earned options is something that employees can buy, the number of undetermined options is not yet eligible, and if an employee leaves the company, they will be added to the ESOP pool.

Exercise occurs when an employee purchase shares under the ESOP.

Exercise Period: The period during which an employee can exercise ESOP to purchase shares. After that, the option expires.

Exercise Date: The date on which each employee exercises the option.

Spread: The difference between the fair value of a stock on the exercise date and the strike price is a spread or discount. This is essential in calculating the exercise tax, which determines the employee's tax obligations when exercising the option.

Stock Valuation Rights (SAR):

Stock Valuation Rights provide employees with the same economic benefits as ESOP but with 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 particular period (that is, the difference between the market price and the strike price on the vesting date). This increase in value is offset by either cash or stock.

Restricted Stock Unit (RSU): 

The RSU is a significantly discounted option and is usually issued at par.

Note that there are significant differences in RSU behavior between India and the United States. The strike price in India is very low compared to the market price, but employees still have to exercise the option by paying the stock's par value

On the other hand, in the United States, RSUs share that employees own when they become vacant. Employees do not have to buy them. Unlike India, this is a one-step process in the United States as there is no concept of RSU practice.

Employee participation can be achieved in a variety of ways. Employees can buy stock directly, receive it as a bonus, receive stock options, or buy stock through profit sharing.

Some employees become owners through worker cooperatives, all of which have equal voting rights. Companies can use the ESOP for a variety of purposes. Contrary to the impression of media coverage, the ESOP is rarely used to bail out problematic companies-at most a handful of such plans a year.

Instead, the ESOP is a new asset that borrows pre-tax dollars to create a stock market for successful, close-knit corporate seconded owners, motivate and reward employees, or use incentives. Most commonly used to buy. In almost all cases, the ESOP is a contribution to the employee, not a purchase.

The ESOP is a type of employee benefits plan that is somewhat similar to a profit-sharing plan. At the ESOP, a company establishes a trust fund, where it brings in its new shares or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, and the company donates cash to the plan so that the loan can be repaid. Regardless of how the plan acquires shares, corporate contributions to the trust are tax-deductible within certain limits.

If you are looking for any Employee stock option plan (ESOP) services or consultants in Noida, Delhi, Gurgaon or anywhere in India, write to us at accounts@especia.co.in. Or Call On :(+91)-9711021268 +91-9310165114



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