Many firms, at some point, have given stock options to their employees as a form of compensation. In some of these companies, these employees had become fabulously wealthy when these stocks were listed in the market. Infosys had granted these options to their employees at different points in time. Many startup firms give these instead of compensation. Let's understand this form of reward in detail.
ESOPs give employees the right to buy shares of their companies at a future date at a pre-decided price. Companies grant ESOPs to their employees as part of their compensation package. In the past, these were given only to senior employees. Nowadays, many firms, especially startups, provide these to their employees across the board.
We should learn about the exercise price, vesting period, and the exercise period. Let's use an example to understand these terms.
Assume that your company gives you the option to buy its shares at an exercise price of ₹ 50 per share starting a year from now, for two years. The two-year period during which you can buy them at any time is the exercise period. After the exercise period passes, you lose the right to purchase the shares. The one year that you wait until you get that right to buy shares is the vesting period.
<aside> ⏳ Some companies also grant ESOPs for which the vesting period is staggered. These may become available over three years. You can exercise 20, 35, and 45 per cent of your ESOPs at the end of the first, second, and third-year from their grant date.
</aside>
ESOPs grant you only an option. You may choose not to buy the shares. When would you pass up the right? You will forgo the opportunity if the exercise price is higher than the stock's current market price. After all, you want to make a tidy profit. After exercising the option, you can sell your shares at any time or after the lock-in period specified by the company is over.
<aside> ⏳ As these options are part of your compensation, these are taxed when you buy and make capital gains on selling them.
</aside>
ESOPs are meant to give employees a sense of ownership in a company and to work keeping in mind the interests of the company's shareholders. These help businesses, mainly, cash-strapped startups attract and retain talented people. A significant proportion of the salary at many startups may come in the form of ESOPs. While the grant of ESOPs may lead to lower cash to take home for the employees, the potential for windfall gains on the sale of these shares in the future makes these valuable.
As an employee, an ESOP gives me a chance to buy my company's shares at an attractive price. In its initial stages, an unlisted startup may grant ESOPs at a low price to reward those taking the risk of working for a firm when it is finding its feet. After the startup takes off or gets listed, the ESOPs may fetch spectacular returns. Listed companies may offer these at a discount to the current market price.
If the financial performance of my firm turns out to be below expectations, not only my salary but also my wealth will be at risk.