Is your company suffering from a high attrition rate and the various measures to curb it have failed to control it? If the answer is YES, you should probably contemplate about issuing Employee Stock Ownership Plan or ESOP to them. ESOP is a tool often employed by an organization for retaining employees who are valuable to them.
An Employee Stock Ownership Plan (ESOP) is beneficial to both the employer and employee, and this has helped the tool to gain immense popularity all over the world. You must be pondering what it is and how it works? In this article, we will explain its mechanism as well as the benefits that it offers. Plus, we will also try to point out the issues related to it.
What is ESOP
ESOP is generally a part of the remuneration package of the employees. It entitles a specific group of employees to a certain number of stock options (shares) at subsidized prices after a particular period of time (vesting period). It is used by the companies to lure the employees into continuing working for the company at least for some more years.
How does ESOP work
The working of ESOP is pretty simple. The employee must complete the vesting period to be eligible to receive ESOP. These are offered with no upfront cost and with an option to decide if they want to exercise their right or not after the vesting period. Companies offer it at exercise price or strike price to the employees.
At the time of exercising the option, if the share price is lower than the exercise price, the option lapses. Most companies allow the employees to buy shares directly from them to curtail the market transaction costs.
ESOP gives the employees a sense of ownership and makes them more determined towards the betterment of the organization. It helps them to attain the full potential of the employees.
As mentioned above, ESOP also allows companies to retain their key employees. Also, the employees receive shares in most of the cases instead of cash as compensation to their hard work, which prevents any significant cash outflow for the company.
For employees, the most significant benefit is that they receive a chunk of ownership of the company and that too at a reduced price. ESOP also creates a perennial inflow for the employees in the form of dividends and bonus.
Types of ESOP
ESOP is an extremely flexible tool, and companies get the liberty to choose from a range of options. The most common types are –
Although we can quickly pinpoint on the various benefits that ESOP offers, there are several issues related to it at the same time.
ESOP is generally managed by a third-party (ESOP Advisors & Third Party administration). It means that the company has to bear many expenses to issue them successfully. There are a lot of legal costs and valuation costs that are also associated with the issue of ESOP. So companies which require a lot of working capital for its functioning are better off without it.
Example of ESOP
A company, X Ltd. of USA has decided to grant 1000 ESOP to employees at a strike price of $100. Half of these are to be vested after three years and the balance after four years.
After three years, if the price of the shares exceeds $100, the options are exercised. Assume that the value after three years is $120 per share. So the employees can get 500 shares at the exercise price of $100 and sell them immediately to make a profit of $20 for each option. X Ltd. has also managed to hold on to these employees for three years. So it’s a win-win situation for both.
After another year, assume the price is $140 every share. It allows the employees to make $40 per share immediately and also helped the company in retaining them for four years.
if you want to invest the funds received from the sale of ESOP judiciously, head over to our article on Investing with Limited Funds right now!