Welcome to our guide on Employee Stock Option Plans (ESOPs), which will provide you with a detailed understanding of this interesting form of employee compensation and ownership. Although we may not cover all the details you may need for your specific company and situation, rest assured that we're here to provide you with a solid foundation to embark on your ESOP journey.
1: What is an Employee Stock Option Plan (ESOP)?
An ESOP is a structured compensation scheme offered by companies to employees. By being part of your company’s ESOP, you get the option to purchase company shares at a predetermined price, so that in the end you may own a piece of the company you are working for. The primary motivation behind ESOPs is to ensure that you and your company have the same goals and try to achieve the same results.
- Are there more types of ESOPs? ESOPs may take different forms, each with its characteristics. Depending on your company decision, you may receive options to purchase company shares at a specific price, be granted actual shares upfront, or receive cash equivalents tied to company stock performance (phantom stock). The choice of type often depends on the company's objectives and what works best for the employees.
- Is anything common to all these ESOP types? ESOPs are not universally applicable to any employee, and often are restricted tp some categories of employees, based on factors such as job roles, tenure, performance, and individual qualifications. Vesting is a core principle present in all ESOPs. Vesting represents a timeframe over which you may gain ownership rights to the granted options or shares. This timeline is meant to encourage your loyalty and engagement, as it rewards your ongoing commitment to the company's growth.
- How do I get to be part of the ESOP? Being offered ESOP participation depends on a combination of factors, which may include your tenure with the company, your individual performance metrics, and sometimes, if you leave the company, your exit status (good or bad leaver). Companies usually define these criteria to ensure that employees who contribute positively to the company's objectives are the ones benefiting from the ESOP.
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2: Is ESOP better for me than receiving a cash bonus?
Well, as always, there are advantages and disadvantages to every situation. Although you may prefer one or the other, typically your company will decide on a specific mix of ESOP and cash bonuses for employees, and you may not be able to change this. What you could definitely do is to change your activity in the company to reach one or another of the goals tied to these types of rewards.
- ESOP advantages. Being part of an ESOP may give you several compelling advantages. The value of your options or shares can appreciate over time, providing you with a potential financial gain. Additionally, ESOPs often come with tax benefits, allowing you to pay less taxes, or to pay them later, than if you get a cash reward (typically both). It may be easier also for the company to give you options or shares than cash. Furthermore, during equity events such as acquisitions or initial public offerings (IPOs), you may stand to realize significant profits from your ownership stake.
- ESOP disadvantages. Where’s no pain, there may be no gain. Accessing the ESOP’s advantages comes with some features that you need to consider. The main one is the potential need for upfront capital to exercise options or purchase shares. Additionally, there may be a time delay before you can fully benefit from your ownership stake. Furthermore, you will participate to all your company ups and downs. The value of options or shares can decline if the company's performance does not raise to your expectations, meaning that in worse cases you may lose money instead of getting a profit.
3. What should I expect if my company has an ESOP?
If your company has, or creates an ESOP while you are working there, you should expect to pass through the following steps:
- Negotiating. The process of joining an ESOP often involves negotiations between you and the employer. During this negotiation phase, you may or may not discuss if you are to be included in the company ESOP, the terms of your participation, the targets you may be required to achieve, your vesting schedule, and your potential ownership stake. Not all of them are typically negotiable, but if you are just starting to work with the respective company, your ESOP participation and the related conditions will be part of your compensation package.
- Granting: The granting phase is the point at which you are awarded the right to own options or shares in the company. This usually occurs according to a predetermined schedule or criteria, as defined by the ESOP plan. The granted options or shares represent the potential for your future ownership, subject to vesting conditions. You will receive information about how many shares / options you could receive overall, and in which conditions.
- Vesting: Vesting is a critical concept within ESOPs, signifying you will get a gradual accumulation of ownership rights over time or upon achieving specific performance milestones. Vesting schedules may be time-based, where ownership rights accrue gradually over a predetermined period, or milestone-based, where you get shares or options by reaching certain company goals. Vesting is meant to motivate you to remain committed to the company's growth and success over time.
- Exercising: The exercise phase is when you choose to convert your vested options into actual shares by purchasing them at a predetermined price, typically referred to as the strike price. Alternatively, if the ESOP involves direct share ownership, you may opt to buy shares at the predetermined price. This decision allows you to become partial owners of the company and benefit from any future increase in share value. However, you may decide not to exercise your vested options or buy the vested shares. They may remain at your disposal for a certain period of time, after which they are cancelled and you cannot exercise them anymore, so check carefully the exercising conditions.
Keeping track of what’s going on during all these phases, following the vested options and exercising them may be confusing for both you and your employer. Nimity solves all your worries, but you should suggest to your employer first to register the ESOP at app.nimity.com/register, and then invite you to open an account with us.
4. Tell me more about Granting
- Who decides how many shares or options I’m granted? The decision to grant options or shares to employees is typically made by the company's management team or board of directors. These decisions align with the company's goals and the desired employee participation in ownership. You may negotiate how many shares / options you will be granted when you start working for the company, or upon some promotion, but other than that, once decided, your package is likely to remain unchanged.
- So there will be no changes once I’m granted some shares / options? While changes to granted shares or options are relatively uncommon, sometimes they may happen under specific circumstances, such as changes in company structure, or regulatory requirements. Also, if you are getting a new position, or in case of exceptional performance, you may renegotiate your ESOP package. Significant corporate events, such as financing rounds or listings on stock exchanges, can impact the value and accessibility of options or shares, and can lead to revaluation of options or shares and may trigger adjustments to the terms and conditions of the ESOP.
- Is there a specific negotiation period? The terms and conditions of granting options or shares are usually negotiated during the onboarding process or at specific intervals, depending on company policies. So check what the company is saying about the ESOP (there are some specific documents at company level describing exactly how the ESOP works).
- How do I see the status of my shares / options? Typically, thoughtful companies provide their employees with a tool or platform allowing them to track their granted options or shares and ensure visibility into their ownership stake.
All steps in your ESOP participation are visible in your Nimity account (register at www.nimity.com).
5: Explain more about Vesting
Vesting is a concept which is always found at the core of any ESOP, as it rewards employees' loyalty and sustained commitment (meaning the company rewards stable and productive employees). By tying ownership rights to your time with the company or performance milestones, vesting should encourage you to remain engaged and contribute to the company's growth.
- Are there more vesting types? There are two primary types of vesting: time-based and milestone based. Time-based vesting will rely on your length of service, gradually unlocking ownership rights over a predetermined period. Milestone-based vesting, on the other hand, is tied to achieving specific goals or milestones (yours or the company’s), resulting in ownership rights upon successful accomplishment.
- What is a Vesting Schedule? A vesting schedule outlines the timeline over which you will gain ownership rights to your options or shares. This schedule is a crucial reference point for you, providing clarity on when you can exercise your ownership rights. In some cases (acquisition, investment round, IPO), the company could accelerate your vesting schedule, meaning all your shares / options still not vested may vest immediately.
- What are Vesting Conditions? Detailed vesting conditions, including the specific milestones or performance metrics, are usually outlined in official company documents or designated platforms. These conditions provide a transparent framework for you to see exactly where you are standing in your progress towards ownership.
- Is there a way to see my vesting situation? The same platform which shows you the granting situation (see the section above) is typically allowing you to also see which shares / options are vested, and also to exercise them (see below).
6: How do I exercise my Options?
- Do I need to pay to get shares / options? Exercising options or purchasing shares under an ESOP may require you to pay a certain price. This applies to either purchasing the options at the predetermined strike price or directly buying shares. This price may be lower than the market price for the shares, but nevertheless it may represent a significant amount for you.
- Do I need to exercise all my vested shares / options? Typically, employees are often granted the flexibility to exercise only a portion of their vested options, enabling them to manage their financial commitments strategically. So, you could choose to exercise only part of your vested shares / options, or even none at all.
- Should I decide immediately upon vesting how many shares / options to exercise? You are not obliged to exercise your vested options immediately upon becoming eligible. You can choose when to exercise within a specified timeframe, allowing you to consider market conditions and your personal financial situation. However, be careful, as this timeframe may be limited, so after a while, if you do not exercise them, your shares / options may be lost.
- Do I need to pay taxes upon exercising? When you exercise your options or purchase shares, there’s always a tax obligation attached. However, how many taxes you should pay and when depends on factors such as the timing of exercise, the difference between the strike price and the market value, and local tax regulations. In each country there are some tax advantages for ESOP members, so be sure to check the specific conditions in your case with your company.
- What happens after I get the shares? Upon exercising options or purchasing shares, you become partial owner of the company, with the potential to benefit from any future appreciation in share value. If the value of the company grows, your share of the company increases too. If the company does not perform well, your shares may lose value.
Exercising options is made easy by dedicated buttons in the employee ESOP dashboard or in the Admin ESOP dashboard.
7: I have some other questions
- What happens if I leave the company during the vesting period? Employees who leave the company may have different outcomes for their vested options or shares based on their exit classification. Those deemed "good leavers," typically leaving for reasons such as retirement or amicable departures, may retain ownership rights. "Bad leavers," who exit under less favorable circumstances, may face restrictions on ownership rights or have to relinquish them. However, shares you already own when you are leaving remain yours under any circumstances.
- Could I sell my shares / options? In some cases, you may have the option to sell your vested shares or options. However, this is subject to the company's policies, regulatory considerations, and any contractual restrictions. Selling can provide employees with liquidity and the opportunity to realize value from their ownership stake.
- How do I know the value of my shares / options? Determining the value of options or shares in an ESOP can be complex and is often tied to various factors. These factors include the company's financial performance, industry trends, market conditions, and potential future equity events. Valuation methods may involve the engagement of professional valuation experts to ensure accuracy and fairness, so most likely you will not perform this valuation on your own. Companies who implement ESOPs usually perform such valuations from time to time, as in some countries this is required by law, while in other countries, even if not mandatory, the company does valuations from time to time for the benefit of the ESOP employees and shareholders.
Profit / loss calculation example
Let's calculate your profit or loss if you buy ESOP shares in your company under different scenarios. Let’s say you buy ESOP shares worth 1,000 EUR, at a strike price of 0.85 EUR at a moment when the company value is 1 mil EUR, and the share price is 1 EUR. We consider the following situations:
- The company value stays the same
- The company value diminishes at 900.000 EUR
- The company value diminishes at 500.000 EUR
- The company value increases at 3 mil EUR.
- Current Company Value: 1,000,000 EUR
- Strike Price: 0.85 EUR (The price at which you purchase the shares)
- Share Price: 1 EUR (The market price per share at the moment of calculation)
Scenario 1: Company Value Stays the Same
- Profit/Loss = (Share Price - Strike Price) * Number of Shares
- Number of Shares = Invested Amount / Strike Price
- Assuming you invest 850 EUR (1000 shares):
- Number of Shares = 850 EUR / 0.85 EUR = 1000 shares
- Profit/Loss = (1 EUR - 0.85 EUR) * 1000 shares = 150 EUR (Profit)
Scenario 2: Company Value Diminishes to 900,000 EUR
- New Share Price = 0.90 EUR/share
- Profit/Loss = (New Share Price - Strike Price) * Number of Shares
- Profit/Loss = (0.90 EUR - 0.85 EUR) * 1000 shares = 50 EUR (Profit)
Scenario 3: Company Value Diminishes to 500,000 EUR
- New Share Price = 0.5 EUR/share
- Profit/Loss = (New Share Price - Strike Price) * Number of Shares
- Profit/Loss = (0.5 EUR - 0.85 EUR) * 1000 shares = -350 EUR (Loss)
Scenario 4: Company Value Increases to 3,000,000 EUR
- New Share Price = 3 EUR/share
- Profit/Loss = (New Share Price - Strike Price) * Number of Shares
- Profit/Loss = (3 EUR - 0.85 EUR) * 1000 shares = 2,150 EUR (Profit)
In summary, your profit or loss from buying ESOP shares depends on the change in company value and share price. In Scenario 1, 2 and 4, you experience profits due to increases in company value or share price. However, in Scenario 3, you incur losses due to decreases in company value and thus the share price. Even if the company value decreases, as long as the company share price remains over the strike price, you win. If the share price decreases below this limit, you lose.
8: What could Nimity do for me?
- Nimity's Role: Nimity serves as a comprehensive platform designed to allow effective management and of ESOPs, streamlining various aspects of the process for both you and your company.
- Tracking Options/Shares: Nimity provides you with a centralized view of your granted options or shares. Using Nimity will keep you informed about your ownership status.
- Vesting Schedule Monitoring: You can rely on Nimity to monitor your vesting schedule. This feature ensures that you are well aware at all times of your progress toward exercising your ownership rights based on predetermined milestones.
- Facilitating Exercise: Nimity streamlines the exercise process, simplifying the steps involved in converting options into shares or purchasing shares at the strike price. This streamlined process minimizes administrative hurdles and allows you to focus on your ownership decisions.
- Complete Overview: Nimity's platform offers you a detailed view of all ESOPs in which you participate. This is designed to allow you informed decision-making and a clear understanding of your cumulative ownership across various companies.
- Secondary Market Access: Nimity will provide you in the future with access to a secondary market for buying or selling shares/options. This market offers liquidity and flexibility, and will allow you to manage your ownership portfolio based on changing financial needs or market conditions.
Remember: you could access all these features and more by opening an employee account at nimity.com.
9: What do some key terms mean
- Options: Options represent the right granted to you to purchase company shares at a predetermined price within a specified timeframe.
- Shares: Shares denote ownership units in a company. If you own shares, you have a stake in the company's performance and growth.
- Granting: Granting is the process by which your company allocates options or shares to you, outlining the terms and conditions under which these ownership rights are offered.
- Vesting: Vesting refers to your gradual accumulation of ownership rights over time or upon meeting specific performance milestones. Vesting should incentivize you to remain engaged with the company and its long-term objectives.
- Milestone: A milestone is a significant achievement or performance goal that, when met, triggers vesting of ownership rights. Milestones are often tied to the company's strategic objectives.
- Exercising: Exercising involves the conversion of vested options into actual shares or the direct purchase of company shares. This action allows you to become partial owners of the company.
- Strike Price: The strike price, also known as the exercise price, is the predetermined price at which you can purchase company shares when exercising options.
- Good Leaver/Bad Leaver: These terms categorize departing employees based on the circumstances of their exit. "Good leavers" exit on positive terms, while "bad leavers" exit due to circumstances less favorable to the company.
- Secondary Transaction: A secondary transaction refers to the buying or selling of shares/options in a secondary market after the initial granting phase. This secondary market provides you with liquidity and flexibility.
- Equity Event: An equity event refers to a significant corporate occurrence that impacts the ownership structure of the company. Examples include mergers, acquisitions, initial public offerings (IPOs), and financing rounds.
At the end
We hope this guide has allowed you to gain a solid understanding of ESOPs in general, and hopefully the ones implemented in your company. Now you're better prepared to navigate your journey as an employee shareholder and make informed decisions about all the steps you need to do as part of your company’s ESOP. Please check our platform (www.nimity.com) and web based resources if you want to know more, and do not hesitate to contact us for specific issues related to Nimity.