Employee Stock Ownership Plans (ESOPs) are set up to give employees an opportunity to own stocks in their companies at negligible or at a discounted cost. This is primarily done to encourage and motivate eligible employees to work towards the organisation’s success and meet profitable goals. ESOPs typically become part of Employee Incentive Programmes and are included as part of pay packages. Over the decades, ESOPs have become a driving force in retaining and attracting a talented workforce, especially within the startup ecosystem.
However, ESOPs are not available immediately to employees. They are held in an ESOP trust fund until the option vests and employees exercise them or retire or leave the company. The life cycle of an ESOPs itself starts with a grant option. Simply put, the company first lays out an eligibility criteria to identify employees who ought to receive ESOPs.
The grant option depends on several factors like the level of the employee within the organisation, performance, salary level, and years of experience. At this stage a grant price may also be determined. This is largely based on the life of the option, volatility of the stock, and exercise price. Most companies offer a Fair Market Value while granting options
The next stage in an ESOPs’ life cycle involves vesting of options. This occurs once the predetermined minimum period after the grant of options is lapsed and the performance-based criteria for eligibility has been achieved. Once this ‘period vests’, only then can an employee actually exercise their right to buy these stocks. Additionally the options granted can be vested by an employee all at once or in a phased manner.
Let’s say a company grants an employee 250 shares over a period of 5 years then a vesting schedule is put in place. This plan may split the vesting period over 5 years making the employee eligible for 50 shares per year with a possible performance-based eligibility criteria. In a study conducted by KPMG, 45% of companies surveyed said that they preferred a vesting period of about 3-4 years. Additionally 59% of respondents preferred a time-based vesting period, while 36% preferred a combination of time and performance-based schedule.
The third stage involves exercising the option. This means an employee can actually exercise his/her right to come into possession of the grant. To make the process smoother the company may create an exercise schedule. This is typically created in line with the vesting schedule and may extend for a period of 2-5 years. The vesting and exercise schedule, while strategically planned to coincide with the company’s growth objective, also determines the length of an employee’s tenure at an organisation.
Having rolled out ESOPs, it is essential that organisations also track the impact of the initiative and determine whether or not the plan’s objectives have been met. According to KPMG, 63% of those who responded to their survey said that they conduct assessments to evaluate the impact of their ESOP plans.
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