Basics of ESOPs Series 1

ESOPs are wealth creation plans that give an employee or a grantee (employee or any other person who has been granted options) the option to buy a certain amount of company shares at a future date either at market value or at a discounted price which is fixed on the date of issuance of the option.

Employees with ESOPs become potential shareholders of the company

• Employees with ESOPs become potential shareholders of the company.
• Upon grant of an ESOP, employees must wait out the vesting period.
• Employees may exercise their vested options (buy shares) during the stipulated timeframe defined in their ESOP scheme document.
• Employees can monetize all or some of these shares when the company announces a liquidity event like a buyback or secondary sale or an IPO (Initial Public Offering).
• The complete or partial monetization of ESOPs (if the start-up has done well and has considerable valuation) will far exceed the standard remuneration of the employee.
• Unexercised ESOPs lapse and return to ESOP pool
• If an employee resigns or is terminated, the ESOPs granted to him will get canceled based on the rules mentioned in the ESOP Plan document. Canceled options will return to the ESOP Pool

In Singapore, these plans are also referred to as Long-term Incentive Plans or LTIP, which encompasses the different variants of stock option plans.

Why create an ESOP for employees?

● Compensate early-stage employees for risk-taking: At early-stage start-ups, employees bring in years of expertise, take a risk by joining the company at a stage where it has not found product-market fit, and help it meet its near-term goals and long-term vision.

● Match standard market remuneration through ‘deferred profit sharing’ or ESOPs: Growth-stage companies can still perhaps match standard market remuneration, but early-stage companies cannot, and thus they offer ‘deferred profit-sharing’ instead of ESOPs. These equity shares are either awarded at the time of joining or during the course of employment (depending on how crucial the employee is to the growth of the organization.

● Align employees closer to organization vision to contribute to shareholders’ interest: Through ESOPs, founders align employees closer to the organizational vision and instill a sense of ownership and trust across the ranks

● Allow employees to share in success as their share options get vested

● Attract and retain identified talents across management and junior employees

● Promote long-term thinking by building long-term goals of the company into the design of LTIPs

Are ESOPs free?

The ESOPs or the stock options are free and granted free of cost to employees, as part of an employee’s remuneration. No grant price is to be paid for grants of ESOPs.

However, to exercise the ESOPs and convert the options into shares, the employee needs to pay the exercise price for the shares. This exercise price is typically decided upfront at the time of granting the ESOPs and stated in the ESOP policy, ESOP Agreement or the Grant Letter.

To be Continued… Watch this space for Volume 2 of the Basics of ESOPs series by Qapita.

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