Employee stock options plan is a type of the employee benefit given by the companies to the employees. Given below are the basic terms, which one needs to be aware of, for understanding the ESOP.
Table of contents
- What is grant date?
- What is vesting period?
- What is exercise price?
- What is fair value of shares?
- How does ESOPs lapse?
- What are alternatives to ESOPs?
- How to value ESOP?
- How are ESOP taxed?
What is a grant date?
The grant date of an ESOP is the date at which options are given to employees for buying shares of the company at a future date.
For example, your start-up ABC Tech gives option to Mr. Stark, an employee of ABC Tech, to buy 1,000 shares at $100, after 5 years. Say, this option is given to Mr. Stark on 1 January 2021.
In this example, 1 January 2021 is the grant date.
What is vesting period?
The vesting period is the length of time an employee must wait to buy the shares, at exercise price, by exercising the option given by the company.
In the above example, 5 years is the vesting period.
What is exercise date?
The exercise date is the date on which employee becomes eligible to exercise the option to buy the shares.
In the above example, 1 January 2027 (that is, 5 years after 1 January 2021) is the exercise date.
What is exercise period?
The exercise period is the time period during which employee can exercise the option to buy the shares.
In the above example, say, Mr. Stark can buy the shares between 1 January 2027 to 31 January 2027. This one-month period is the exercise period.
What is exercise price?
The exercise price is the price at which employees are entitled to buy the shares of the company. The exercise price is generally lower than the fair value of the shares.
In the above example, $100 is the exercise price.
What is fair value of shares?
The fair value of shares is the price of the shares of the company for external parties to the company. In case of listed company, it usually is the traded price. In case of unlisted companies, there are various valuation methods to determine the fair value of the shares.
It is important to determine the fair value of shares as compared to exercise price, as the difference forms the basis of many for valuation and tax implication.
How does ESOPs lapse?
The ESOPs given to an employee is often with certain conditions.
For ex., an employee must complete at least three years of service OR an employee must achieve certain level of performance.
If these conditions are not fulfilled, ESOPs are lapsed for the employee and he cannot exercise the option to buy the shares.
What are alternatives to ESOPs?
There are several alternatives to ESOPs, like Restricted Stock Units, Employee Stock Purchase Plan and Stock Appreciation Rights
How to value ESOP?
The valuation of ESOP is done using several complex options pricing models, like, Black-Scholes-Merton Model and Binomial Model.
How are ESOPs taxed?
The employees and company have different tax implications for ESOPs. Also, the recent tax law has given benefit to the employees of a start-up companies.