ESOPs – How they can help attract and retain the best talent
Attracting the best talent in the industry and then retaining your best employees are two of the hardest challenges faced by business owners. Employee Stock Ownership Plans (ESOPs) present a solution to this problem by sweetening the deal for new joiners, and by giving an incentive for your best talent to stay back in your organization.
They also help in aligning the interests of employees with your business objectives. By offering employees a stake in your business through stock options, ESOPs can foster a sense of ownership, engagement, and commitment among your key team members. Employee Benefit plans, like ESOPs give your employees the confidence and satisfaction of knowing that their skills are valuable to their employer.
Understanding ESOPs
Employee Stock Ownership Plans (ESOPs) are among the most popular employee benefit plans that provide your employees with the option to be part-owners of the company by acquiring shares free of cost or at a discounted rate, in a time-bound manner. ESOPs can be issued to permanent employees and directors of the company or a subsidiary company inside or outside India.
You have to understand that ESOPs are complex and time-consuming. Your employees may find it hard to understand, and also tedious since there is a vesting period between issuing of shares and exercising the rights. Research alternatives and ensure that ESOPs are the best option for your company before proceeding.
Key Considerations for Implementing ESOPs
Before implementing an ESOP, organizations must carefully consider several key factors both internal and external to the organization. It is a reward for commitment and excellence, and hence there is bound to be mixed reactions among the employees who are given ESOPs vs. those who are not.
Organizational culture
Employee Stock Options work well in organizations with transparency, trust, employee recognition, and participation. It should not be used as a trap to retain talent who would then feel stifled by the conditions. Assess your organization’s culture, and thoroughly look at the results of employee satisfaction surveys before implementing ESOP.
Compliances
Compliance with government regulations and laws is mandatory while implementing ESOPs. In India, the ESOP rules are mentioned in the Companies Act of 2013, the Companies (Share Capital and Debentures) Rules of 2014, and the SEBI (SBEB and Sweat Equity Regulations) guidelines, of 2021. Organizations must make sure that the Stock Option Plan is structured keeping these rules in mind.
Valuation
Since the subscribed share capital is usually increased when employees exercise their option, the company needs to engage valuation experts or financial advisors who will determine the rates at which the stocks are to be made available to the employees. Shares are given below Fair Market Value (FMV) or at the value, to make it attractive for them. A thorough Financial Planning and Analysis is done at this stage to ensure that your business has the capability to meet the financial commitments made in the ESOP.
Communication with employees
The management should effectively communicate the purpose and benefits of the ESOP implementation, and also clarify any questions that the employees might have about the time frame and procedure for vesting.
Smooth Implementation
ESOP is a time-consuming process. Having an expert who has experience in implementing ESOPs handling the entire process, will ease the stress ensuring adherence to policies and better communication with the employees. Proper records must be kept so that there is no lack of clarity in the future.
Taxation of ESOPs in India
ESOPs are taxable in two stages in the hands of the employees.
- At the time of exercise – At the time of exercising of options, it is taxed as perquisites in the hands of employees on the difference between the Fair Market Value as on the date of exercise and the exercise price.
- At the time of sale – At the time of sale of exercised options, it is taxed as capital gains on the difference between the sale price and the Fair Market Value as on the date of exercise.
How to implement ESOP successfully
There are a few steps to implementing ESOP effectively in your organization.
1. Feasibility Study
Feasibility study involves an analysis of the organization’s financial capability, valuation, organizational culture, and employee satisfaction to assess the readiness to implement ESOP. The commitment of the management is the most crucial factor in implementing ESOP successfully since it involves a lot of time and effort.
2. ESOP Plan Design
Organizations keep 7-15% of their equity as an ESOP pool, most of the time by diluting the equity of current shareholders. It can also be done by increasing the total share capital to add more shares. The equity plan should clearly define the vesting period for the stock option, and any other conditions that the employees must fulfill.
In India, there is a minimum of 12 months ‘Cliff period’, which is the time period an employee must work in the organization before they can vest their stock options.
3. Valuation Certificate
Just like you would do a valuation for your company while you are seeking investments, ESOP also requires your company to have an expert complete a thorough valuation of the financials. The valuation report presented to the board or stakeholders will act as a guide for them to approve the process before you can go ahead with the ESOP.
4. Communication with employees
The process of implementation involves the approval of the plan by the Board of Directors and the shareholders, filing necessary forms with the Registrar of Companies, issuing the Grant letters to Employees, and obtaining their acceptance.
Once is ESOP design is approved by the board or the management, it has to be communicated to the employees clearly. Transparency is of utmost importance at the time, especially for small companies where there would be apprehensions about the ESOP. Meeting key employees one-on-one to explain the plan will help ease the concerns and make ESOP implementation smoother.
5. Implementation
Implementation of ESOP involves setting up processes to track the allocation and vesting of shares. The ESOP design should be flexible enough to account for changes in the company structure, funding, and scaling up or down according to the market conditions.
6. Regular review
Regular valuation and review of the organization’s financial performance is essential to ensure that you have the financial capability to honor the ESOP commitments and that the plan is aligned with your business objectives. You should also assess the success of the ESOP plan in acquiring and retaining good talent. Valuation is also required to account for the ESOP expenses.
7. Continual improvement
As your organization grows and gains more experience, you might discover flaws in ESOP, or shortcomings that you had not accounted for. An annual review of the Stock Option Plan will help you re-orient yourself and make corrections to the ESOP design.
Successful ESOPs in India
In India, several startups have successfully implemented ESOPs and gained benefits for themselves as well as their employees. In 2023, Razorpay and Swiggy announced massive ESOP liquidation programs worth $75 million and $23 million respectively. View the report on ESOPs in Indian startups here.
Zerodha, India’s largest stockbroker is one of the new-age companies that has successfully implemented ESOP, in addition to Zomato and PayTM.
Experience the benefits of a well-defined ESOP
Employee Stock Ownership Plans (ESOPs) can be a very powerful tool for acquiring and retaining talent, rewarding employees for talent and commitment, and aligning employees’ goals to your organization’s business objectives. When implemented well, ESOP can foster a sense of ownership and engagement for your core team members.
A good ESOP implementation needs careful planning, resource allocation, expert advice, transparency with employees, and complete commitment from the management. If you would like to explore ESOP or other employee benefit plans for your organization, reach out to Finavi CFO today. Without over 14 years of experience partnering with small and emerging businesses in their financial journey, we can guide you toward a smooth and efficient ESOP implementation.
POSTED ON: June 22, 2024 BY ADMIN
TAGS:
Employee stock option plan, ESOP, stock option plans