An Employee Stock Option (“Option”/ “ESOP”) is a long-term incentive instrument being offered by a Company to its employees under its ESOP Plan (“Plan”). The “Company” here may be the direct employer of the employees receiving a grant of ESOPs or may be a parent or subsidiary of such direct employer company. The employees get an ownership right in the target Company in the group by receipt of ESOPs which can be converted into the shares of the Company. The Options are issued at a pre-determined price (called the “exercise price”) which may be equal to or lesser than the market value of shares at the time of grant. The employees exercise the ESOPs later if the share price is higher than the exercise price at the time of exercising. The ESOPs have four different life cycles i.e., Grant, Vesting, Exercise and Sale of the shares. Whereas the Grant is an entry into the Plan with expectation of earning benefits, the Sale means exit from the Plan with actual benefits depending on the growth in the value of the Company from the date of grant to date of Sale.
Grant is an event when the employees receive Options they are entitled for in the Company. The number of Options is generally different for different employees or different classes thereof and essentially depends on their criticality to the Company or the entire group. The ESOPs are granted with a vesting period i.e., a minimum period an employee must be with the organisation. Till the vesting period is over employees cannot take the benefit out of these Options. The value of the Options depends on the growth of the Company i.e., if the Company performs well the value of the Options increases and vice-versa.
Once the vesting period is complete the employees can exercise these Options within the predefined exercise period i.e., the period during which the employee must pay the exercise price and taxes to the Company to buy the shares. If the exercise period is over then the Options granted to the employees get lapsed. Employees earn a notional gain till the Options are being exercised. If the employees exercise the Options, then such ESOPs are converted into the shares of the Company. As alternate of exercise requiring exercise price and taxes from the employees, most unlisted Companies structure the Plan in such a way that employees get the gain (net of exercise price and taxes) upon exercise of Options.
The ESOP gains necessarily generate from the value of the Company which takes time for a meaningful appreciation and the vesting period is accordingly designed to factor-in this value growth. It can be concluded that to earn the monetary rights on ESOPs, an employee must have to be within the organisation until the vesting period is complete. Then, exercise such ESOPs and get the benefit which was promised at the time of the Grant.
Hence, ESOPs do not mean money right after the Grant; instead, it is only after the Options get vested and exercised. This often leads to a long-term concept spanning at least 3 years and more from the date of Grant.