What Is ESOPs How Does It Work? | How You Can Skyrocket Your Wealth With ESOPs

What is ESOPs?
What is ESOPs?

You know very well that you can not become rich or cannot make too much money by just doing the job. But now it’s possible to create wealth as an employee through ESOPs.

An Esop is an Employee stock option or can say Employee stock ownership that gives the employee ownership stake in the company they work.

Many people in India don’t know what is ESOPs? how does it work, But slowly people are getting to know about it because the startup ecosystem in India experiencing a boom like never before.

Let me clear one thing here is Esops is not a stock, it’s a stock option. It means the company in which you are working giving you an option that you can buy the stocks of a company at a discounted price…

When you buy the stocks of the company it means you also have a small portion of ownership in a company which is a great thing.

After leaving the company you can sell those Esops and make a good amount of wealth for yourself.

The main reason Indian start-ups give Esop options to their employee so that they can retain the employee for the long term. because it’s very difficult to find talented people like you ;)…

And the company doesn’t want to lose you that’s why it provides ESOP to you.

It gives a sense of ownership to the employee and motivates them through equity ownership and because of that they don’t leave the company.

Also Read: Before Explaining about ESOP if you want to know how to invest in the stock market then just click on this link 

How do ESOPs Work?

If you are working in a company that providing you ESOPs it means they want you to never leave their company. Let suppose if you are working on company “X” and they are providing you Esop.

After 3 months later you decide to leave that company & you takeaway ESOPS with you, in this case, this is beneficial for you but not for the company.

Because of this what they do, the company puts ESOPS in a vesting period. I know it’s wandering in your mind that what is this Vesting Period?

A vesting period is you will not get the ESOPs immediately. The company gives them to you over a period of time. This ensures that you are definitely not going to leave the company if you really want to get those ESOPs.

In India vesting period is of 4 years it means if you received 1000 ESOPs then the company will give you 250 shares every year.

There is Another perspective of this is, no company wants their employees to work there only because of ESOP, even if they are not doing well but he is there just for ESOPs.

So instead of yearly vesting, they provide ESOPs to their employees quarterly. Thus every three months you get Esops. let’s take the same example…

You received 1000 ESOPs, so instead of giving you 250 every year company will give you 50, 50 Esops till the three quarter and in the last Q4 quarter you’ll get 100 Esops.

I hope now you understand that what is vesting period.

Benefit Of Having ESOPs

The best thing about Esop is whenever the startup will do well suppose the startup gets a lot of funding from the investor then you can earn a lot of money by selling your share at that particular valuation.

Esop motivates the employee to work harder for their company because it has some stakes of a company and it gives a sense of ownership to them and because of this, they don’t quit their job.

How is ESOP Calculated?

Now, you have ESOPs & After a few years later you decide to leave the company and you want to convert your Esops into stock by selling them.

but you don’t know how to evaluate the value of the Esops you have.

To Calculate the value of ESOP you have to first find out the valuation of the company.

Suppose, Valuation of the company is 10Cr and the Total No. of shares in the company is 10akh then the price of each share will be Rs 100.

Market Value of the company=Total No. of shares x Price Per or Each share

Do remember that Esops is not stock it’s a stock option to convert Esop into stocks, company gives you a particular period of time to convert esops into shares which known as the Excercise period.

The exercise period can range from 3 months to 10 years, this means at any time if you leave the company, this means that at any time if you leave the company, within three months or 10 years you’ll have to convert your Esops into stocks.

When the company granted you Esop, you expect the valuation of the company to increase in the coming years so that you can sell your share at a higher price.

Esops In India

There is an important term called cliff, Cliff is when you complete the vesting period in the company, the company wants you to that at least spend 1 year in their organization after that they’ll give you the Esop option.

In the first year, you get zero vestings, When you complete the one year in their organization after that they grant you esops.

Basically, most companies have a minimum cliff period of one year which means that you have to give at least one year in the company after which the first portion of your option grant vest.

ESOP Taxation in India

According to the govt of India Esop is one of your income and the company has given you the esops at a highly discounted price which known as prerequisite value and it’s a part of your income.

Whenever you convert your esops into shares it means you are creating extra income for yourself and this income falls under the income tax.

For example, the Fair market value of a share is Rs 1000, and the exercise price per share is 500 then it will include in the salary of the employee under section 17 (2).

In the same way, it counted as an expense in the book of the employer.  Start-up companies under sec 80-IAC it says that at the time of allotment of shares to your employee TDS shall be deducted within 14 days of

  1. After the expiry of 5 Financial years from the end of the relevant financial year in which shares are allotted or
  2. From the date of the sale of such shares by the employee or
  3. From the date on which the employee ceases to be the employee of the company

TDS to be deducted based on the rates inforce in the financial year in which shares are allotted or transferred.

when you sell the shares & make some profit out of it then that profit is taxable and capital gain tax levied on it, whether it is long-term capital gains or short-term capital gains.

Considering how long you have kept the shares and they would be considered as short-term capital gain or long-term capital gains.

This tax would be levied on the amount when you sell the shares whose value is more than the fair value, it means when shares allocated to you its share fair value is Rs 1000…

and you sell it at Rs 1500 then you’ll have to pay tax on the Rs 500 because you already paid tax on a discounted price as a salary income.

Capital gain tax=Sale value-Fair value

Capital gain tax=1500-1000=Rs 500

What are the advantages and disadvantages of ESOPs?

There are many questions wandering in the mind of the people, are ESOPs good or bad? are ESOPs worth it? so don’t worry I’m here to answer all of the questions that are wandering in your mind?

By reading the advantages and disadvantages, you will know for yourself whether ESOP is good or bad for you.

Advantages Of ESOPs

  1. Start-up companies attract talent through ESOPs & this is the best way to attract & retain talent.
  2. ESOPs give job satisfaction to Employees because it give a sense of ownership as they are also shareholders of the company.
  3. ESOPs act as an incentive for employees it removes the necessity of providing cash incentives and it saves cash outflow of the company.
  4. When the growth of the company increases, the value of your share will also increase.

Disadvantages Of ESOPs

  1. If the company doesn’t do well then automatically the value of your share will also fall and you have to bear the loss
  2. There are a lot of complicated rules and regulations attached to ESOPs.
  3. To provide stock ownership to the employee companies must have proper systematic administration and there are always costs associated with the administration of the esops. if the company doesn’t have the proper staff for providing stock ownership to the employee then they are inviting a risk issue in violation of the legal rule
  4. When you convert Esop into share you have to pay tax and it heart you because you haven’t received the money yet still you have to pay tax to govt for this by simply converting ESOPs into stocks/shares. so most of the people wait for the right time to convert their shares into money, it can be any venture funding or IPO so that they can exit easily. and when you sell the stocks and make some profit out of it then you have to pay for that profit because it considers as a capital gain.

I hope I have cleared all your doubts related to What is Esop & how does it work, if you still have any queries then you can comment on this post, I’ll try to clear all your doubts.

FAQ – What Is ESOPs?

Q1. Is ESOP good for employees?

Ans. It depends on how much a company or startup paying attention to their employees if a company is employee-friendly then obviously ESOPs is good for the employee.

But if the company is not taking seriously then it becomes difficult for the employee to convert their ESOps into shares & then convert those shares into money. because there are so many rules and regulations attached to the ESOP which sometimes become a headache for the employee.

Q2.What are the different types of ESOPs?

Ans. Employee Stock Option Scheme(ESOS)
Employee Stock Purchase Plan(ESPP)
Restricted Stock Units (RSU)
Stock Appreciation Rights(SARs)
Phantom Stocks

Q3. Can I cash out my ESOP?

Ans. Yes, you can withdraw cash from ESOP by converting them into shares after then you can sell your shares. You just have to wait for the right time to sell your share it can be IPO or any big funding only you have to contact the administration of your company to help in the liquidation process.

Previous articleHow To Invest In The Stock Market In India For Beginners [The Complete Guide]
Next articleBest Shares To Buy In India For Long Term: Which Can Deliver Incredible Return To Investors
I love value investing, My goal is to create financial awareness in India For this I created a “unlockmyfinance” website and on this website, I teach people about finance & stock market

LEAVE A REPLY

Please enter your comment!
Please enter your name here