Before you read any further, we want to clarify that this article is not about stock options for your local fast food chain. It’s about employee stock option plans. These are a type of equity compensation plan that companies can adopt as part of their benefits package and compensation strategy. An ESO is essentially an incentive plan that gives employees the right to buy company shares at a predetermined price within a time frame after they join the company. This article will demystify employee stock option schemes and make it easy for you to understand what these schemes are and how they benefit both employees and employers. Read on to know more!
What is an Employee Stock Option Scheme?
An employee stock option scheme is a contractual agreement between an employer and an employee, granting the employee the option to buy a certain number of shares in the company at a future date and at a predetermined price. Stock options are a type of equity compensation. When a company grants you an option to buy shares in it, it is essentially giving you a stake in the business and you become a partial owner in the company. When you exercise your option and buy shares at the predetermined rate, the company will have to buy them from you at the same rate. This is the fair market value of your shares and is determined by the company’s board of directors based on a few factors like the company’s performance and financial health.
Rights and Responsibilities of Employees Under ESO
Employees have certain rights and responsibilities under a stock option plan. Let’s look at them in detail: Right to buy company shares at a predetermined rate – Employees have the right to buy company shares at a predetermined rate at the end of their service period. The rate at which employees buy the shares is usually based on the fair market value of the shares at the time of the purchase. Right to sell company shares – Employees can also sell company shares at a rate agreed upon with their employer. This is usually determined by the fair market value of the shares at the time of the sale. Right to exercise – Employees have the right to exercise their stock options upon the termination of their service period. They can exercise their options before the stipulated period if the company terminates their services before the end of the service period. Responsibility to abide by terms and conditions – Employees must abide by the terms and conditions of the stock option plan. They must also inform the employer if they have any reason that would prohibit them from exercising their option.
Advantages of an ESO to Employees
There are various advantages of an ESO to employees. Let’s look at them: It is a great way to encourage people to join your company – ESOs have been used as an incentive to attract the right talent to a company. You can offer a certain percentage of the company’s stock as part of the employment package to attract top talent. It encourages employees to stay with the company – Employees are more likely to stay with the company once they have exercised their stock options. This is because they have more to lose if they leave the company prematurely. It gives employees a sense of belonging – ESOs make employees feel like they are a part of the company. They feel motivated to work harder for the company because they have a stake in it. It provides employees with a long-term financial incentive – ESOs provide employees with a long-term incentive because it takes time for the company to reach the fair market value of the shares.
Disadvantages of an ESO to Employees
Now that we have seen the advantages of an ESO to employees, let’s now look at the disadvantages of an ESO to employees. Let’s look at them in detail: It can be difficult to know the value of the shares – Since the value of the company’s shares fluctuates, it can be difficult for employees to know the value of the shares. Some companies set a fixed rate that the shares will be bought at. This makes it easier for employees to know the value of their shares. It can be difficult to sell the shares – Selling the shares can be difficult if the company is not listed on any stock exchange. If a company is listed, then it is easier for employees to sell the shares. However, it is difficult to know the true value of the shares when selling them. It is difficult to hold on to the shares – It can be difficult for employees to hold on to the shares because the company might be hit by an unforeseen event. This could reduce the value of the shares and make it difficult for employees to sell them.
Disadvantages of an ESO to Employers
Now that we have seen the disadvantages of an ESO to employees, let’s now look at the disadvantages of an ESO to employers. Let’s look at them in detail: It is expensive to implement – Implementing an ESO can be expensive. You have to pay employees the value of the shares at a certain point in time. This cost can be difficult for smaller companies to bear. It can be difficult to estimate the value of the shares – It can be difficult to estimate the value of the shares at a certain point in time. This can make it difficult to settle the terms of the options granted to employees. It can be difficult to hire the right people – Companies must hire employees who have the ability to stay with the company until the shares reach the fair market value. This can be difficult for employers because they don’t know what the future holds.
Employee stock option schemes are contractual agreements between an employer and an employee, granting the employee the option to buy a certain number of shares in the company at a future date and at a predetermined price. These schemes can be a great way to hire and retain talented employees. However, they can be expensive to implement. Companies must hire employees who are willing to stay with the company until the shares reach their fair market value.