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ESOP: All about employee stock ownership plan

[] ESOP is an employee benefit programme which offers employees an ownership interest in the organisation.

What is ESOP?

ESOP stands for employee stock ownership plan or employee stock option plan. ESOP is an employee benefit programme which offers employees an ownership interest in the organisation. They are direct stock, profit-sharing plans or bonuses for the employees and the employer has the sole decision making power, as to who gets these benefits. There are a set of rules and regulations every company lays down through which employees can gain access to the ESOP programme.

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Why do companies offer ESOPs to their employees?

Companies offer ESOPs to their employees, to ensure that the employees stay longer with the company. In companies with high attrition rates or low salaries, this helps make the package competitive with other companies. The companies usually offer ESOPs at the end of the financial year and thus, any employee who would have otherwise left the company will tend to stay longer.

It also helps the company retain good employees. ESOPs usually are long-term benefits that the company offers to their employees.

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ESOP: How does it work?

An employee gets the option of buying a few shares or stocks of the company after working for a specified time with the company, which is called the vesting period. After this period, the employee gets the option of becoming a stock owner in the company and sharing the profits that the company earns.

ESOPs: Advantages for employees

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The employee gets a chance to sell his stock when need be and earn money. When an employee sells their stock, they usually earn a lot. An excellent example of the same can be Google. Google ended up making all the employee stockholders rich as it went public.

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ESOPs: Advantages for employers

Making the employees a shareholder in the company makes them more responsible and forces them to work harder. Apart from it, it also makes them feel rewarded for working hard and makes them stay longer with the company. The employer also does not need to provide cash bonuses or rewards to the employees, preventing cash outflow. This helps the employer to get more profits and also a better workplace.


Disadvantages of ESOPs

  • ESOPs are very difficult to manage.
  • Even if you may hire people to manage these, you will still need personnel within the company that have championed this art.
  • ESOPs are usually good options for companies looking at a change of ownership or liquidity.
  • Once put in place, ESOPs also require close monitoring to prevent any legal issues in the future.
  • ESOPs require a significant amount of financial support to stay working and thus, may not be very successful. For companies, who are looking at a revamp, this may cause a paucity of funds and also wastage of resources.

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ESOPs: Tax implications

For an employee, ESOP are taxed at two levels.

First, when the employee exercises the option. The employee has to pay the difference between the fair market value on the date of exercise and the exercise price as a prerequisite.

Second, while selling it, in the form of capital gain. If the employee sells the share for more than the fair market value, they will be liable to pay the capital gains tax.

This tax depends on the period of holding, that is from the date of exercise up to the date of sale. Long term shares are the listed shares that are held for more than 12 months and the short term shares are the ones that are sold before the completion of 12 months. Presently, the long term capital gains on shares is taxed at 10% for amounts exceeding Rs 1 lakh.

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Category: Must Knows

Debora Berti

Università degli Studi di Firenze, IT

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