What is ESOP? An employee stock ownership plan (ESOP) is a type of employee benefit plan that gives employees stock ownership in the company.
Employee stock ownership plans encourage employees to give their all because the company’s success translates into financial rewards.
When a company or a business attains complete maturity and becomes a full-fledged business, it becomes hard for such a company to then raise funds from conventional methods such as small-time loans, seek investment from Angels and VCs or approach any other private lending boards.
These methods are more suited for startups and small to medium-scale businesses who have very little scope to raise funds on their own or with not much credibility to attain big loans from major banks.
Therefore, larger companies rely on methods such as IPO sales or ESOP shares distribution to manage their equity, raise loyalty amongst employees, and reward employees of the company efficiently.
The ESOP shares unlike IPO shares, may not help raise huge funding but will help preserve the company’s shares and award preferential rights and grants to its employees, ensuring that the talent is well compensated for and retained.
How does ESOP Work?
ESOP or Employee stock option scheme helps the companies to manage the capital of the company in a trusted and democratic way by including the management, the directors, the investors, and also the employees of the company who have all helped in furthering and developing the company.
An employee stock option plan
An employee stock option plan is a way to award grants to employees – which means that the employee has the option to buy a share at a discounted value, much lower as per their agreement at a strike price instead of the actual market value.
This means that every employee has the option to buy a share, but to exercise or not to exercise this right is completely up to the employees.
Some employees may not exercise these grants provided. But ESOP allows them to sell these grants back to the employer whenever it is called for.
This helps the employees to gain monetarily without actually having to trade the stock options at all.
ESOP share price
However, this is a great opportunity for employees who wish to own shares in the company, as the ESOP share price is always much lower for employees than the market price of the share.
Employees who wish to own stakes in the company they work for can monetize and benefit from this opportunity to a great extent.
ESOP is one of the best ways to promote employee loyalty, branding, and talent retention and to offer an emotional connection between employees and the company.
It is an opportunity for the employees to have a stake in the company capital and therefore be part of the equity.
But unless the grants are actually exercised based on the grant letter, the employees would still not be able to use these options to the full extent.
Benefits of ESOP
There are several benefits of ESOP schemes when employed in a business organization. As discussed before, some of these are highlighted again:
- Helps in retaining long-term employees
- Reward and recognize employees
- Help in creating a pool for stock options from equity
- Provide certain benefits for excellent employees
- Help in raising funds from within
- Helps in building emotional connections between company and employee
- ESOP-based companies are exempt from Income taxes
- A method of incentivizing company employees
These are some of the most notable benefits of ESOP in the current market trend.