What is ESOP? Experts explain benefits and risks involved

ESOPs: Every organisation’s goal is to hire and retain employees that are a perfect fit for the job. To do so, they provide employees with several perks and benefits to keep them on-board, and one such benefit is Employee Stock Ownership Plan or Employee Stock Option Plan (ESOP).

What is an ESOP? 

Employee Stock Option Plan is a type of perk the company offers to its employees wherein they have a right to buy shares of the company at a specified price on a future date. 

According to Nirvi Ashar, Fundamental Analyst at Religare Broking Ltd, ESOPs motivates the employees and makes them responsible.

“ESOP serves two purposes. On one side the employee is motivated, whereas, on the other side the employee feels responsible and works towards performance improvement of the company,” she said.

She further added that ESOPs are given to a certain set of employees as decided by the company’s management.

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Benefits of ESOPs

According to experts, ESOPs give employees an option to buy shares of their company at a lower price. “The companies give select employees the option to buy the company's shares at a lower price after a predetermined vesting period,” said Sanjay Moorjani, Research Analyst at Samco Securities.

Another benefit is that the employee gets a share in the profit of the company through dividends.

“Employees get the benefit of ownership and they share the profits of the company in the form of dividends. In addition, they are motivated and in turn, they support the growth of the company,” Nirvi said. 

What are the risks involved in ESOPs?

According to Moorjani, the success of the ESOP depends on the overall performance of the company and employees should be aware of several risks, including stock price risk, diversification risk, leverage risk, and poor performance of company.

Another thing to note is that the Employee Stock Option Plan is taxable and comes with a lock-in period.

“ESOPs to employees come with a lock-in period and employees will need to stay with the company until a certain time period to exercise the option. Besides, it is subject to taxation as well, as the employee is exposed to the risk of liquidity. Also, the value of ESOP would increase with improvement in the performance of the company,” said Nirvi further shared.

Relation between ESOPs and Initial Public Offerings (IPO)

Experts say that ESOPs and IPOs are interconnected. Explaining this, Nirvi says, “An IPO is good news for employees of unlisted companies which provide ESOP opportunities. So, post IPO subscription, the company gets listed on the stock exchanges and employees are also able to trade their shares (post lock-in) and earn profits." 

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