What are ESOPs?

ESOP is an acronym for Employee Stock Options. It is one of the tools used by a company to reward its employees and also to inculcate employee ownership. ESOP is as the word suggests - an option, or a choice - to buy your company shares at a future date.

   What are the terms of ESOPs? What do they mean?

(a) What is grant of options? Grant of option is issue of the Right provided by the company to its employees to buy equity shares of the company.

(b) What does vesting of options mean? The Right granted vest (become exercisable) on fulfilment of certain pre-defined conditions. Options vest once these conditions are met. Vesting can also be explained as ?earning the right to exercise the options.?

(c) What is vesting period & vesting percentage? Vesting period is the period an employee has to wait till he can exercise his options. It is mentioned in the grant letter at the time of grant. Vesting percentage refers to that portion of total options granted, which you will be eligible to exercise. Usually Options vest over a period (Vesting period) of 3-4 years in lots (Vesting percentage).

(d) What is exercise price? Exercise price is the price that you have to pay to convert your options into shares e.g. if the options are granted at an exercise price of Rs.5 and you want to exercise 100 options then you have to pay Rs.500 (5 x 100) while exercising the Option.

(e) What is exercise period? This is the period within which you can decide to exercise your options. This period starts from the date of vesting.

   What´s the benefit or advantage to me?

An option is valuable as it gives you a right (with no obligation) to purchase the shares at a pre-set price. As a result, if the stock price increases, you will still be able to purchase the shares at the price set on the grant date. However, if the stock price decreases after the option is granted and vested, you may choose not to exercise the options. Thus your interest is safe guarded. While there is no cap on the up-side return, there is also no risk of downward movement of the company?s stock price. Gains from Options are also taxed less as compared with other remuneration components.

   What are the tax implications to Option holders?

At the time of grant and vesting of options No tax is payable at the time of grant and vesting of options as per current Indian tax laws.

At the time of exercise of options As per the current tax laws, Income tax is payable on exercise of stock options as follows: Taxable value = Number of options exercised *[(Market price on exercise date) - (exercise price)] This amount is taxed at the normal tax slab rates. The Company shall recover this tax amount from you at the time you exercise your options.

At the time of sale of shares Taxable value = Number of shares sold*[(Net selling price) - (Market price on exercise date)]. This gain is taxed as a Capital gain. The rate of tax will depend upon the period of holding of shares post exercise of shares. Taxation laws may change periodically and it is recommended that you consult your Tax Advisor to understand the tax implications on sale of such shares.

   What is ESOP funding?

When you exercise your Options it is likely that you do not have spare funds to pay for the Exercise price and taxes. ESOP funding is available from Banks and other finance companies as a loan. This loan is generally available only if the shares of your company are listed. The terms of loan vary based on market conditions.

   What is cashless exercise? How does it help me?

Cashless is a mechanism for exercise of options with a zero cash outflow for the employee.

Here, the employee authorises the ESOP Trust to execute a cashless exercise. As per the employee instructions, the Trust will either sell part of the shares to cover the employee obligations (exercise price +taxes) and transfer the remaining share to the employees, or, sell all the shares and remit the net proceeds to the employee.

Cashless mechanism is a hassle free way for employees to maximise their gains without paying or borrowing any money.

   What does ESOP work for a foreign national?

No special approvals are required at the time of grant of options to foreign nationals. They are treated at par with the Indian employees. However, for exercise of options and holding shares, foreign nationals are required to open a trading and a demat account in India. Company is required to handle some compliances with the RBI.