Employee Stock Option Plan (ESOP)

These days in campus interviews, majority of the firms which come for placements are startups. Most of the students I have spoken say we would like to join a startup as the learning opportunity is greater and the chances of making a windfall is even higher. Which is true, if the startup you have chosen to join makes it big. There are many such examples available in the market. The biggest dream a startup sell’s is ESOP’s and that is the reason the joining CTC looks big, compared to other companies. Remember that these stock options would make you a rich person only on paper, as converting them to cash would take a lot of time and conditions. First you have to remain with the organization till the vesting period, secondly, unless the entity is listed, you do not have any exit option and have to rely on what the organization says is the worth of the option. Thirdly the ESOP conditions are not easy.

I know of a young smart lady, who joined a startup for internship, there was a big bonus they had promised, but as the days came closer, she realized that she was not even halfway close to receiving the bonus. The chances of a startup closing are much higher, therefore the value of your ESOP will be worth zero unless the company really makes it big. In case it’s time to buy the shares based on your ESOP, be careful if the company has not been listed, as if it does not list, you would end up holding dud papers. ESOP’s are given by these organizations for 2 reasons, one they cannot afford to give high salaries, because they are short of cash and secondly it works as an employee retention tool. Now the tax aspect.

Tax is to be paid on the date when the ESOP is converted to Shares, i.e. you decide to put in money, this really hits you hard, as you need to put in cash and you are also taxed for the difference between vesting price and market value (book Value). Again when you actually sell the shares, it is taxable as capital gains. You would be lucky if you the shares are listed on the exchange, as if they are listed and you sold within a year of the shares being vested, it is short term capital gains taxable at 15% and if after a year, then tax free. The situation is different, if it is not sold on the exchange. The short term capital gains is taxable as per your tax slab and long term would be taxable.