This is a series of posts which will cover aspects like –

What is ESOP?

Why it is given to employees ?

Who is eligible ?

Type of ESOPs ?

When you will get actual shares ?

What are terminologies like allocation, cliff, vesting, exercise etc.?

How it is taxed ?

What are the exit/sale options ?

But everything will be in simple English. So this is not for financial professional who prefer to use complicated terms and are looking for very nuanced cases.

ESOP is an Employee Stock Options i.e. option given to the employees of an company to buy the share of the company they work-in.

Company gives this option most of the time to their senior employees, but the trend is changing and many companies now give the option to mid and junior level employees as well.

Interesting question, which many of you may have thought about – why ESOP are given ?

Idea behind the ESOP is to give employee the sense of ownership in the company, which will keep them motivated and align with the vision of the founders/ management. Also generally ESOPs comes with requirements like – employee has to stay in the same company for certain number of years and perform at a certain level which ensures that there is less turnover of the employees and performance level of employees are high, which in-turn benefits the company.

There are broadly two ways in which company issues ESOP to its employees –

1. Company gives an option to employee to buy certain number of shares after he/she has completed certain number of years of employment and performed at expected level. Employees get the actual shares of the company, which they can choose to keep with themselves for a long period of time or sell it (how and when to sell is covered in the series of linked posts).
2. Virtual form of ESOP generally known as Phantom shares or Stock appreciation rights (i.e. SAR). Company allocates benefit of certain number of shares to the employees without giving them option to buy those shares i.e. If employee has completed certain year of employment and performed well then employee will be eligible to receive the appreciation in the value of the shares which were allocated to him in the form of cash (lets say as – One time bonus).

You may wonder, why company uses option 1 or 2, so let me give some insight on the company thought process.

Generally ESOP (option 1) is given to the senior employees, which are limited in number and are strategically important to the company, it ensure that only few employees are added to the shareholders list (which comes with its own challenges i.e. longer the list harder it is to take decisions etc.). Also, even after senior employee have left employment they will have vested interest in the company in the form of shares they hold and will generally have good intentions towards the company and founder.

Option 2 is given to the larger base of employees which company wants to encourage and keep motivated, but do not want to add the large number of employees to the shareholders list. This is also good for such employees because generally ESOP/ Phantom stock/ SAR are not big part of their compensation and they do not need to get into the hassle of buying and selling shares.

For more detail, refer following links in the series

What are terminologies like allocation, cliff, vesting, exercise etc.? – https://financegrail.com/esops—grant-vesting-exercise-cliff/

How ESOPs are taxed ? – https://financegrail.com/esop-exercise-of-shares-and-cash-impact/

How to exit from ESOPs ? – https://financegrail.com/sale-options-for-esops-cash-and-wealth/

Also, to give you some perspective, how valuable ESOPs can be for your and your financial journey, refer following internal and external reference –

Wealth creation and ESOP – – https://financegrail.com/wealth-creation/

Latest ESOP buyback from employees by India companies – https://entrackr.com/2021/07/startup-employees-pocket-100-mn-through-esops-in-first-half-of-2021/

Why ESOPs are being bought back – https://www.entrepreneur.com/article/371481