Understanding ESOPs: A primer for employees

An ESOP or Employee Stock Option is distributed to the company’s employees in the form of stock options. The structure of an ESOP plan can range from simple to complex and, while an opportunity to become owners of the company you work for is always an attractive proposition, it is important to understand how ESOPs actually work.

Let me take you through what is known as ESOP Life Cycle through the example of a person — let’s call him Raghav — and the company he works for — let’s name it Netceptor Technologies.

Raghav joined Netceptor in 2017 when it was an early stage startup, and his contribution has helped the company grow. In 2018, the Netceptor board decides to reward its staffers through a new scheme called ‘ESOP-01-2018’.

On the first day of FY 2018, Raghav receives a copy of the ESOP scheme, along with a grant letter. The letter states that he has been granted stock options to buy upto 800 equity shares of the company at an exercise price of $25 per share, discounted from the current market price of $62 for per share. The ESOPs vest quarterly over a vesting period (the minimum period that the employee has to serve to be entitled to the stock option) of four years. This means that part of Raghav’s 800 ESOPs will vest (i.e. become available to exercise) every quarter, and at the end of four years all 800 of the ESOPs will be available for Raghav to exercise. The caveat is that there is a cliff period of one year (a cliff is when the first portion of an option grant vests). Which means Raghav has to work with Netceptor for at least a year more before a part of his granted options start vesting and he is able to exercise them. The ESOPs have an exercise period (the period post vesting, during which the employee can exercise an option to buy the shares) of ten years. Our man continues working for Netceptor for the next two years, and receives further such option grants in 2019 and 2020.

In 2020, Raghav decides to take stock of all his ESOPs and find out how much he has accumulated in the last three years.

ESOPs Dashboard

Raghav logs into his TOPPEQ stock connect account, which displays vital and relevant information related to his ESOPs, including critical dates and time periods. More specifically, a detailed vesting schedule helps him get an idea of how many options he would stand to gain in the coming years as well as when he would be able to exercise them. But let’s get to the specifics now.

Across three schemes, Raghav has been granted ESOPs to buy 3,440 shares, of which he has already purchased 300 shares. He can currently purchase shares worth $81,375 for only $15,000. If Raghav continues to work with his company (which he co-owns now) until the completion of the vesting period for all his ESOPs, he is likely to exercise grants worth $5,33,200 at the Netceptor’s current share price of $155 per share.

ESOPs Dashboard

While going through the details of the scheme on his Toppeq dashboard, Raghav remembers his teammate, Anurag, who left the organisation after having spent a year and half with Netceptor. This was the period in which the company’s valuation had gone up, and Netceptor’s share price had leapt from $62 to $155. If Anurag had understood the value of stock options, especially in the long run, maybe he would have stayed back. Anurag could never get the hang of the entire process or track the key dates and events related to Netceptor’s ESOPs, and his option expired before he could utilise them.

Vesting Schedule

ESOPs Dashboard

Raghav is happy and plans to use the rewards to meet some of his financial commitments, including repaying the outstanding amount of his housing loan. He decides to exercise his 525 vested options by paying the required exercise price. This converts the vested options into shares. He is then able to sell these shares to a strategic
investor at the market price.

Transaction and Holding statement

ESOPs Dashboard

Raghav is glad that he is set to be debt-free, and also happy that he has a stock account that has not only helped him understand the ESOP Cycle but also allows him to monitor each event and corporate action in a timely manner and attain his financial goals in a prudent manner.

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