Know about ESOPs!

By BankBazaar.com | August 7, 2013

It depends upon the company’s management to decide who gets how many options. But as a general guide, people in higher management are offered more options. Sometimes people in special projects which brought the company more profits are offered more options. Suzlon, as discussed earlier has given equal number of options to all its employees. The CEOs and key managers in companies like L&T, ICICI Bank, HCL Tech, Biocon, Dr.Reddy’s Laboratory, HDFC Bank, Dabur, etc have huge assets in their portfolios because of their stock options.

ESOPs (Employee Stock Option Plans) were hottest during the ‘dot com’ boom years among software and internet based services companies. They are picking up now after many years. The difference is that now-a-days even manufacturing and banking companies are offering ESOPs to their employees.

What are ESOPs?

ESOPs, which give employees a stake in the ownership of the company, are provided by the company to employees to boost their motivation and loyalty.

ESOPs give an employee the right to buy the company’s shares during a predetermined time period and at a predetermined price (strike price). Generally the strike price of the shares are offered to the employees at par or at a discount to the prevailing market prices.

ESOPs are structured in such a way that the option to buy the shares at a discount can be exercised only

after a certain period of time, which is known as the vesting period.

So for example, an employee may be able to exercise his right over his shares after a vesting period of one year. In some instances, he may be allowed claim to a certain percentage of shares, known as the vesting percentage after one year and the rest over the next few years.

Can a Non-Listed Company give ESOPs?

Yes, even a non-listed company can give ESOPs.

In fact, ESOPs in innovative, fast growing, unlisted companies were the reason many professionals made their millions in the Silicon Valley in USA. This trend however is yet to pick up in India.

When does one pay to get the shares?

Generally, in practice, there is no need to make a payment when ESOPs are allocated to the employee.

Recent case as example

Last week Suzlon, had announced an ESOP covering almost 90% of its employees to celebrate its 15th anniversary.  Here, options of 1500 shares are allocated equally to all its eligible employees. The price at which the shares are offered (strike price) is at Rs.72.70/- per share compared to the current market price of about Rs.73/- per share.

The vesting date is the day the employee gets the right to own the share at the strike price. In case of Suzlon, they get the first ownership of 500 shares after one year (vesting date) and 500 more every year for 2 more years.

The actual date on which the employee wants to reap the benefits of his shares is the exercise date. In the case of Suzlon this can be upto 31st march 2014.

What happens when there is an increase or decrease in the market price?

Here, the whole point of the option is that the employee reaps the profit of any increase in the market value of the shares on the chosen exercise date and if the market value is not significant or is lesser than the strike price, he can choose not to exercise his right, which then is the crux of the ESOP.

Can I transfer the right for the ESOP to somebody else?

No, this is not allowed. The ESOP is provided to an employee as a benefit for his/her specialized skill / contribution to the company. This cannot be transferred to anybody. However after the shares are bought by the employee he/she is free to trade/ transfer/ gift the shares to anybody as per his/her wish.

How many options am I eligible for?

It depends upon the company’s management to decide who gets how many options. But as a general guide, people in higher management are offered more options. Sometimes people in special projects which brought the company more profits are offered more options.

Suzlon, as discussed earlier has given equal number of options to all its employees.

The CEOs and key managers in companies like L&T, ICICI Bank, HCL Tech, Biocon, Dr.Reddy’s Laboratory, HDFC Bank, Dabur, etc have huge assets in their portfolios because of their stock options.

How are ESOPs taxed?

The stocks bought using an ESOP are taxed as fringe benefit when bought. The value to be taxed will be the difference in value between the actual value at which shares are bought and the market value of the shares.

They are taxed as normal shares are taxed at the time of selling. The usual rules related to capital gains tax will apply, now. Post the implementation of the New Direct Tax Code, the proceeds of the sale will be added to income and taxed accordingly. The calculations related to the taxation are beyond the scope of this primer and will be discussed in a separate article.

Will employees get special benefits in an IPO?

Yes, generally employees are given some special considerations during an IPO (Initial Public Offering). An Employee Stock Purchase Plan (ESPP) is the preferential allotment of shares most at preferential prices to employees when a company comes out with an IPO. Typically in India, shares are offered at about 5% discount to the final offer price to the general public.

As employees the additional benefit can be that some portion of the shares offered may be preferentially allotted to them. So there is a higher chance for an employee to get he shares allotted to him/her. This is definitely an advantage for employees.

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3 thoughts on “Know about ESOPs!

  1. Shiva

    Good Article. Would like to add the following

    1. Rationale for ESOP in Unlisted companies: To make the employees the real stake holders i.e. Long term interest as against the short term interest. While performance is rewarded through performance Bonus, value careation is rewarded through ESOP and also the employee retention achieved.
    2. ESOp tax: On exercise of ESOP the value of the shares as on the date of exercise less the price paid for exercise is treated as salary income.For un listed company the value of shares is the fair value as certified by the classI Merchant bankers. -Abssiva

    Reply
  2. diseaurdimagse

    The Authorities who is the master of all to be informed must devise such a scheme that all those companies in the country who have been existence of a set period and are upto certain region of turnover must by rule issue beneficial ESPOP to their employees. It is such a sad story that many of the employees are holding for long their scripts that one day they may get any benefit but for years no benefit (divident nauturally for every year) is accrued and the last hope presently is that they may be given discounted shares on the minimum holding or set number of shares held by them. This must be enacted to strict to ward of the disadvatagesous status of holding for long.

    Reply
  3. Shiva

    Tax on ESOP:
    As per the current taxation provisions, the difference between the value of shares as on the date of exercise and the exercise (Option) price shall be deemed to be income under the head salaries and the employer is liable to deduct TDS thereon. In case of listed companies the value of the shares is the market value of shares and in the case of unlisted companies the value of shares shall be the fair value of shares as certified by a Class I Merchant banker ( registered under SEBI)

    Reply

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