ESOPs are (Employee Stock Option Plans) few call them Employee Stock Ownership Plans in India. When an employee gets ESOPs from the company where he/she works, he/she gets the right to purchase a certain number of shares in the company at a predetermined price after a predetermined period or periods.
It is generally given as a reward for performance or tenure with the company. It also serves as a motivational tool as once you own stock, you actually own part of the company and if the company does well the stock value rises. ESOPs also help in retaining employees. Companies give ESOPs in parts & there is vesting schedule. So today an employee may get 3000 shares which would be given in sets of 1000 over a period of time.
Usually employees have to wait for a certain duration to exercise their right to buy shares. This period is called vesting period. If the employee does not exercise the option of buying the shares within the vesting period, the options lapse and the employee does not get any rights. IT firms had started this trend but now many companies in different sectors give ESOPs to employees – even the startups are depending on ESOP to attract talent.
How does an employee benefit from ESOPs?
An employee can create wealth from ESOPs if the timing (luck) is right and the company does well. ESOPs should be exercised when the ESOP value is at a lower price than the market value of the shares on that day. (to save tax but there are other factors that should be considered before exercising)
ESOP gain but Zero Risk Strategy
In employee want to take zero risk – he can exercise when company share is trading at a premium. If the employee sells the shares at the right time, he/she can make a neat profit – For example, if an employee gets 300 shares at Rs. 100 per share and the vesting period is 1 year, he/she can exercise the option of buying the shares after 1 year. It is advantageous if the employee exercises the option when the market value is greater than Rs.100 at that time.
How do ESOPs help the company?
The company can preserve cash and dilute ownership if required. The company benefits by giving ESOPs to employees. Employees benefit from the increase in the share price, so they will focus on working towards making the company successful.
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