Types of ESOP in India: A Comprehensive Guide
Employee Stock Option Plan(ESOP) is one of the most common ways to incentivize employees in India. A company provides its employees with an option to buy its shares through a stock option plan. The employee can execute their option by purchasing the stocks at a value set by the provisions of the option agreement.
By offering an ESOP, employees can become partial owners of their company without any personal financial investment. In the event of the company’s success, employees may have the opportunity to sell their shares for a profit.
An ESOP permits employees to purchase a specified quantity of company shares at a predetermined price after a certain period, typically a fixed number of years. Prior to exercising their option, employees must undergo a pre-determined vesting period. The individual is required to remain employed with the company until they have exercised a portion or the entirety of their stock option.
Employee Stock Option Plan (ESOPs) can serve as a component of a company’s buyback initiative or as part of a larger strategy to retain valuable employees.
There are six different types of ESOPs in India.
1. Employee Stock Option Scheme (ESOS):
Employee Stock Option Scheme (ESOS) is a type of stock option scheme that grants an employee the right to buy shares of the business directly from the company at a predetermined value. The option is contingent upon achieving certain performance objectives during a designated vesting period.
After the vesting period, employees have the opportunity to exercise their right to own the offered stocks at a predetermined fixed price. Consequently, upon completion of the vesting period, there is a possibility of acquiring the shares at a lower value (which was established at the time of issuance) than the current market price.
Employees can just let it expire and receive nothing if they don’t want to exercise their right. Upon exercising their right, employees possess complete ownership of their stocks and voting rights in the company, in addition to being eligible to receive dividends.
2. Employee Stock Purchase Plan (ESPP):
The Employee Stock Purchase Plan (ESPP) is an ESOP that provides employees with the opportunity to purchase shares of the company stock at a discounted or lower-than-market price. By participating in the ESPP, employees can regularly invest in the company’s stock, thereby augmenting their ownership stake in the organization. Whenever an employee invests in the stock, they are entitled to a portion of the company’s earnings, referred to as dividends.
3. Restricted Stock Units (RSU):
Restricted Stock Units (RSU) is an ESOP that grants employees restricted stock units. Employees are allowed to exercise them in order to convert RSU into real stocks when some restrictions, which can be either time-based or performance-based, are lifted. Usually, employees are granted RSUs in exchange for a particular amount of time spent working with the company or when certain performance milestones are achieved.
4. Restricted Stock Award (RSA):
Although RSA and RSU may seem alike, they are distinct from one another. RSUs are simply a commitment to provide stocks upon completion of a designated period or accomplishment of a performance target (or both in some instances). In contrast, RSAs immediately issue stocks to the employee, allowing them to own the shares with all of the related advantages, such as voting rights and dividends from the grant date.
5. Stock Appreciation Rights (SARs)
Stock Appreciation Rights (SARs) are the best choice if a company wants to give out stock benefits to its employees but does not want the shares to be liquidated. It grants the employee the right to receive an increase in the price of the company’s stock once a specified time period has passed before the expiration date.
6. Phantom Equity Plan (PEP):
There is a subtle difference between PEP and SARs, although they are often used interchangeably. Phantom Equity Plan also does not involve any real stock and only pays the increased share value benefit to the employee. PEP imitates a bonus, rather than a stock option, that companies bestow upon employees on a predetermined future date, and it does not allow employees to exercise it at their discretion within a designated period.
ESOPs serve as an exceptional means for companies to draw in top-notch talent and retain their enthusiasm and involvement. There is a vast array of employees who aspire to possess a stake in the organization they are employed by and these programs aid in accomplishing this objective without obligating employees to undertake an excessive amount of risk.
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