ESOP Share Introduction
Long gone are those days when employees were compensated with just their basic pay package. Nowadays, employers offer much more than salary slips; one such offer is the Employee Stock Ownership Plan (ESOP).
ESOP is full-formed as Employee Stock Ownership Plan. Under this plan, ESOP shares are allotted by the employer to the employees at a low or negligible cost. These shares remain in the ESOP trust fund till a specific period, after which the employee can exercise the option. Both startups and big trading companies use ESOP shares to avail of the innumerable benefits.
The functioning of ESOPs
Employers of a company determine the number of shares to be offered under ESOPs, their net value, and the beneficiary employees who could access them. The employees then give ESOP shares, and a grant date is noted.
The vesting period can be defined as when ESOP shares remain in the trust fund until employees get the rights to exercise them. The vesting date is the date on which the vesting period expires; until then, employees have to work for the organization, or they will lose the right to benefit from ESOP
After the vesting date, employees can exercise the ESOPs and buy the allotted shares at a much lower value than the market price. They can also sell these shares to obtain gains on their holdings.
If the employee leaves or retires from the organization before the vesting period, the company is bound to buy back the ESOP shares at the current market value within 60 days.
Advantages of ESOP plan for Employees
ESOP shares are beneficial for employees in the following ways:
- They obtain ownership of the company: By owning the stocks, employees also share the company's ownership and have rights to the company's share capital.
- They can get a dividend income: Besides the usual paycheck, employees can enjoy the dividend return, distributed as the profit earned on the company's shares every year.
- They can buy the company's shares at a minimal amount: The price of shares under the ESOP plan is much lesser than the original market value, and the employees can avail of them.
- They can sell the ESOP shares: Employees can sell the shares when their market value is heightened to get profits as an additional income.
Advantages of ESOP plan for Employers
Employers also share benefits under the ESOP plan in the following ways:
- They can retain employees: Employees have to wait to exercise their options because of the vesting period. Employers use this to retain them in the company.
- Employees output more productivity: As they could profit more from the increment of the company’s shares, they work more diligently to produce greater results.
- ESOP plan attracts talented employees: The ESOP is a conditional tool by which employers attract and retain talented employees. Startups use this to lure in good talents in the initial days when high paychecks are not practical.
Disadvantages of ESOP plan
The disadvantages are as follows:
- Absence of diversification: Employees often focus on the company's share, investing only in the ESOP shares. This results in a lack of diversification, restricting the employee to invest in healthier options. Moreover, employees put all their savings into the same company, which provides them income, insurance, etc. If the company goes bankrupt, employers will instantly lose all their retirement savings besides other major losses.
- Newer employees are limited: Older employees attain more benefits and voting power because of their continuous contribution to the ESOP plan. This limits the opportunity of newer employees to present their voices in annual meetings and important conferences.
- Reduction in the percentage of ownership each share holds: according to the ESOP plan, as newer employees are granted ESOP shares, each share's ownership is diluted.
Tax implementation of ESOP plan
The tax implications of the ESOP plan are as follows:
- Taxes are imposed in two different ways: at the time of exercising the share after the vesting period and at the time of selling the shares to obtain capital gains.
- When buying the shares, taxes are implemented on the perquisite, which can be calculated by subtracting the FMV with the buying amount under ESOP.
- Taxes on capital gains are implemented based on their holding period, which can be categorized under STCG and LTCG.
Employers often provide these benefits with no upfront costs. The company holds such shares in the trusted fund until the employee retires or resigns. They can earn an increasing proportion of share for each working year. Upon retirement, the company buys these shares back, and employees are provided with a lump sum or periodic payments. The shares are again distributed or marked void. On voluntary retirement, share papers cannot be taken but only the cash payment can be availed.
An employee-based company is a corporation where most of the shares are held by its own employee. These companies do not distribute their capital rights equally.
Though ESOP shares are taxable, these are a great practice that benefits both the company and its peers. Companies like Flipkart and Myntra used the ESOP plan to boost their economy in the initial stages greatly. Exercising these benefits enables employers to align the interest of the employees with that of the shareholders.
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