Navigating ESOPs Successfully in the Context of IPOs

Navigating ESOPs Successfully in the Context of IPOs

The company distributes shares in the ESOP pool overtime to employees. It does this as compensation or perks for their services. The company may give these shares to employees as a portion of their incentive package. They often become theirs after a specific amount of time. Or when they accomplish performance goals. Staff members can use employee stock ownership plans (ESOPs) as a retirement fund option. They can also align their interests with the company's success.

What is the application of ESOPs?

Companies at all stages of development adopt ESOPs because of their many advantages. These include boosting employee retention and motivation. ESOPs also give companies a competitive edge in attracting talent. They can improve employee performance, thereby raising the company's profitability and value.

Employees with stock options have the right to buy a set number of company shares at a set price. They can exercise this right until the option expires. Employees can choose to sell their business stocks. They can use the proceeds to support other aims. Or, they can hold onto their shares when they begin trading on the free market. This depends on any restrictions.

What differentiates IPOs from ESOPs?

Employers have used employee stock option plans, or ESOP plans, for many years. They use them to reward workers' achievements. They encourage better performance. They align workers' interests with the company's shareholders.

Employees can pursue value appreciation in their equity shares and stock options. They can do this through an initial public offering (IPO). They can also do this through the next listing of equity shares. Unlisted businesses usually time the exercising of options under ESOP schemes. This is to coincide with their IPO and to avoid potential tax implications.

Equity Dilution and Its Effects

When the company issues new shares, current shareholders experience a decrease in their ownership proportion. This includes founders and early investors. This is known as equity dilution. This occurs in the event of more funding rounds. It also happens when staff members exercise their stock options. This increases the number of outstanding shares.

Founders' viewpoint:

Dilution of shares can have both benefits and drawbacks for entrepreneurs. ESOPs are an effective way to attract top talent. They also inspire staff to work long hours for the company's success. Yet, issuing more shares to support ESOPs may reduce the founders' ownership stakes. So, it may diminish their potential influence over the company.

Employees' viewpoint:

ESOPs give employees a special chance to own a share in the business they work for. They can profit from its financial success. These options can make up a sizable amount of a worker's total compensation package. They match the worker's goals with the long-term success of the business.

Direct Route and ESOP Trust for Listed and Unlisted Businesses 

Traders must choose the trust route when trading in secondary shares. This is true for both listed and unlisted companies. Administrative concerns differ based on a company's status. This can be public, private, listed, or unlisted. 

For ESOP purposes, listed businesses may use secondary shares up to 5% of their equity capital. Furthermore, any public company may loan the ESOP trust to buy up to 5% of the company's shares. Employees buy shares using the company's paid-up share capital and free reserves. This rule applies to listed and unlisted companies. The amount of shares also depends on this borrowing cap.

Private enterprises enjoy greater freedom and freedom from restrictions, enabling them to engage in trust operations more extensively. Corporations, particularly listed ones, are subject to ESOP program limitations, including trading shares and operations restrictions. However, private trusts can be registered regardless of their status.

The following are just a few of the crucial positions in an ESOP Trust:

  • The settlement is a pre-IPO company. It gives staff members, or an ESOP Trust restricted shares or share options.
  • Trustees are a recognized trust business. They maintain limited shares or share options. These belong to the beneficiaries or participants.
  • Recipients: Workers who take part in an ESOP Trust

Why do pre-IPO companies favour an ESOP trust?

Many Chinese companies consider their employees their most valuable assets. They usually set aside some of their shares in the Cayman entity for an ESOP pool. This may happen before it is listed on the stock exchange. The ESOP pool is part of a share award scheme. It's used during corporate restructuring for an international IPO.

If the firm updates its share award scheme and participant list before the IPO, a part of the restricted shares or share options may vest in some ESOP participants. This can happen for a variety of reasons.

An employee who becomes a shareholder may not be as motivated as they were before the IPO. They will still be a shareholder even if they resign and join a competitor. That is not what an employer expects.

Once restricted shares or share options vest, an ESOP participant will have the right to become a shareholder. They do this by exercising the option.

The company should establish an ESOP Trust to hold the restricted shares or share options. The trust also holds ungranted shares. It is for the benefit of the ESOP members. This would be the ideal course of action in such a situation. An ESOP Trust provides the company with flexibility about rules.

For example, when to distribute or vest. How to reallocate restricted shares or share options. It also helps the company keep talent. This is until a six-month lock-up period following the IPO. It allows them to become conditional shareholders.

How do we navigate ESOPs successfully in terms of IPOs?

When a firm is getting ready to go public, there's more talk about ESOPs inside the corporation. Early planning is crucial if plans call for a nontraditional approach. For instance, selling a firm to an employee stock ownership plan (ESOP). It can also be made public through an initial public offering (IPO).

The Change in IPO

The dynamics of share dilution and ESOPs shift when a firm goes from seed to public offering. Employees will be able to convert their ESOPs into genuine shares and cash them out through the IPO. This is a liquidity event. This shift may hold special importance for founding members of the team. They have been with the organization from the beginning.

An IPO allows unlisted businesses to be listed on stock exchanges. It allows employees to trade shares and benefit from growth in share value. Also, it provides both opportunity and risk for shareholders.

Employee Benefits Based on Share and Sweat Equity

The Companies Act of 2013 and the Companies Rules of 2014 govern employee stock option plans. They apply to both listed and unlisted businesses. Listed firms need to follow the SEBI Share Based Employee Benefits and Sweat Equity (SBEBSE) Regulations, 2021. These regulations govern the relationships between a company's ESOP Navigation and IPO.

Extra charge

When they first vest, you receive ESOPs for less than their fair market value. So, people regard the distinction as a motivator. If you convert your ESOPs into stocks, you will need to pay taxes on that amount in the associated fiscal year. This should happen only after they vest. An excellent ESOP policy would let you keep the ESOPs until a liquidity event, like an IPO or exit. This way, you'd only owe tax once the ESOPs' value started to grow.

Planning an Initial Public Offering

If your company goes public, you have options for handling your shares, including IPO and stock vesting. Start planning early and consider tax implications before making a decision. Integrate this knowledge into your tax strategy.

For instance, following an IPO, RSUs vesting by their timetable may cause you to go into a higher tax bracket. But there is a way to offset those consequences.

SEBI laws issue employee stock options.

The companies' stock options are subject to SEBI regulations after listing on stock markets. Shareholders must approve stock option plans developed before the IPO once it has occurred. Before awarding new options or shares, pre-IPO schemes need confirmation.

Even if former employees received shares after exercising ESOPs during employment, they won't be able to sell for one year after the IPO.


Post-IPO stock option programs are necessary to generate value for the company's major contributors. They also help leave a lasting legacy. Agile administration tools are necessary for managing stock options. For this reason, Especia offers free templates and an open-source ESOP policy. They help you manage your ESOP programs. You can customize our ESOP management solution to meet your changing needs; it is completely paperless.


  • Employee stock option plans (ESOPs) are a way for employers to reward employees' achievements, encourage better performance, and align their interests with the company's shareholders. They can be pursued through an IPO or the next listing of equity shares.
  • ESOPs offer employees a unique opportunity to own a share in the business, matching their goals with long-term success. Traders must choose the trust route when trading secondary shares, with listed businesses using up to 5% of their equity capital.


Differentiate ESOPs and IPOs:

Employers use employee stock option plans (ESOP) to reward workers' achievements, encourage better performance, and align interests with shareholders.

Employees can pursue value appreciation through IPOs or listing equity shares, with unlisted businesses timing exercise to avoid tax implications.

What is the transition in IPO?

A firm transition from seed to public offering is transforming share dilution and ESOP dynamics. Employees converting ESOPs into shares is a liquidity event. IPOs enable unlisted businesses to list on stock exchanges, benefiting employees and shareholders.


Contact Us for ESOP Services, ESOP Financial Services, ESOP Tax Advisory Services, ESOP Regulations in Delhi, Noida, Gurgaon, and all across India: write to us at Or Call On :(+91)-9711021268 +91-9310165114

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