ESOP meaning along with Examples

Overview

ESOP schemes are growing in India, ESOP plans are an unique way to compensate the employees which not only offers competitive compensation to employees but also helps to align employees’ interests with that of the organization. ESOP shares are being offered by upcoming startups like DeHaat (an agricultural startup), ideaForge (drone manufacturer) and also by unicorn brands like Nykaa, Zomato, and Razorpay to retain the organization's top talent and increase their competitiveness in the industry. Zomato has recently announced ESOP shares worth Rs. 3500 Cr. to its employees whereas Flipkart on the other hand, stands out as amongst the creators and holders of the largest ESOP pool worth Rs. 17,000 Cr. in India.

ESOP Meaning

ESOP (or Employee Stock Ownership Plan) is a flexible way to compensate employees by granting them options to buy shares at discounted price of the organization and giving them ownership interest in the organisation/company of which they are a part of. ESOP benefits employees to acquire the shares of the company at a price lower than the market value which is predetermined between the company and the employee which is called the Grant price. The grant price is usually in line with the face value of the shares in the initial stage of their business journey. The employee is eligible to get these shares underlying ESOP at the expiry of a certain period or on achieving set milestones.

Key Terms used in ESOP Scheme

1. Grant Date: The date on which the options are offered to employees by the employer is the grant date.
2. Grant Price: It is the discounted price at which stock/equity shares of the company can be purchased by the employee at a future date. (also known as Strike Price and Exercise Price)
3. Vesting Period: Vesting Period is the time period between the grant of the options and the date on which the options will vest to the employee or become exercisable. In India, the minimum vesting period has to be of at least one year.
4. Exercise Period: Exercise Period is the period during which the employee can exercise his option to buy the shares i.e. the employee gets the right to purchase the shares.

How does the ESOP Scheme work?

To become eligible to claim the ESOP shares, the employee has to work with the company for the decided called the Vesting Period which is usually around 1- 4 years in India. Once the vesting period is over, the Exercise Period starts in which the employee has limited time to exercise his right to buy shares (usually 1-2 years). Once the employee has exercised the options and acquired the shares the employee has two options either to keep the shares or sell the shares in the secondary market like a stock exchange . If the employee does not exercise his right to buy the shares, then the option lapses. All the details like Strike Price, Vesting Period, and Exercise Period are listed separately in ESOP Agreement and are agreed upon between the employer and the employees in advance.

ESOP Example 

ABC Limited wants to use the ESOP pool to compensate their top performing employees for the record breaking sales and revenue growth. Assume that:

• The face value of the equity shares of ABC Limited is Rs 100 while they are being traded at a market price of Rs 5,000 on the National Stock exchange as at the closing of the previous day.
• Today (grant date), the company now grants options to its 2 employees (Rohan and Riya) for 100 shares each at a grant price of Rs 100 which is equal to the face value. To explain in simple terms, each employee has an option to buy 100 shares of ABC Limited at a price of Rs 100.
• But the options would vest after a period of 4 years (Vesting Period) i.e. the employees can only exercise their right to buy the shares if they work with ABC limited for a period of 4 years from the date of grant.
• The exercise period is 2 years which is the time period during which the employees can exercise the options after options have vested. After 2 years the options would lapse.
• The market value of shares after 6 years (4 years vesting period and 2 years exercise period) jumps to Rs 8,000.

Outcome 1: Rohan worked for 4 years and then at the end of 2 years exercise period exercises his ESOP shares:

Rohan pays Rs 10,000 which is 100 shares * Rs 100 (grant price) and gets 100 shares of ABC Limited. The current market price is Rs 8,000 on the National Stock exchange. Therefore, Rohan makes an immediate gain of (Market price worth Rs. 8,000 – Grant price worth Rs. 100) *100 shares = Rs 79,000.

Outcome 2: Riya worked for 4 years and gets the options but does not exercise her ESOP shares during the 2 years period:

Riya has not exercised the options in the Exercise Period of 2 years, so, she won’t receive any shares.

Zomato ESOP Case Study

Zomato, a food ordering and delivery platform where you can search and discover local restaurants, order food, and have it delivered reliably and quickly launched in 2010, has recently announced it’s ESOP Plan 2024 wherein it has allocated shares 18.26 crores to its employees. The face value of the shares is Rs 1 and the shares will be granted at face value only with Vesting Period of 5 years. The market price of Zomato shares on the date grant was Rs. ~200 per share which was allocated at Rs 1 making the ESOP valuation worth Rs. (Market price worth Rs. 200 less Grant price worth Rs 1) * 18.26 Cr. worth shares Rs. 3500 Cr.

Conclusion

ESOP shares have now started to gain popularity in the Indian corporate space as it offers benefits on the part of both employee and employer. The ESOP shares foster a sense of belongingness and loyalty while at the same time employees show unwavering dedication and enthusiasm to take the company to greater heights. ESOP pools can also provide an effective way of structuring and funding the long term capital needs of the company. Thus, the ESOP scheme is increasingly being adopted by multiple startups, unicorns and by large multinationals as well.