How to make the most out of your ESOPs.

India has been witnessing rapid growth in startups, especially in the latter half of the past decade. Presently, it has the world's third-largest startup ecosystem. India has upward of 50,000 startups, while investments by private equity and venture capital firms have touched a record-high of USD 77 billion in 2021. In India, there are 44 unicorns (companies valued at USD 1 billion or more).

High-value exits through initial public offerings (IPOs) of companies such as Zomato, Nykaa, and PolicyBazaar were also seen in 2021, further boosting confidence (and valuation) in and of Indian startups. Shows such as Shark Tank have been timed to perfection, taking advantage of the startup wave that has gripped the nation. It has brought viewers one step closer to making it big and familiarised them with industry buzzwords.

One such buzzword is ESOP, which stands for Employee Stock Option Plan.

How does an ESOP work?

It’s a strategy used increasingly by startups that enable an employee to buy shares of the company at a discounted price, in a bid to retain their services for longer. The employer offers the employee the option to buy a specific number of shares at a future date, at a discounted price. The employee can then purchase those shares and sell them for a profit later.

The employer saves on immediate cash outflow, while the employee has the opportunity to create long-term wealth at a fraction of the cost. You become a partial owner of the company, a la Shark Tank!

Here’s how you can make the most of your ESOPs:

1. Negotiate a short vesting period

Employers would want to have a longer vesting period as it ensures you stick around for longer. But long vesting periods may result in you missing out on investment opportunities. The company could buy back shares from the ESOP pool during this vesting period as a part of a funding drive, leading to a missed opportunity.

2. It’s all in the timing

You get the option to buy shares at the decided discounted price after a vesting period. After this, the exercise period (pre-defined) begins, during which you can purchase the shares. To get the most value out of your investment, it's crucial to time your exercise right. During this moment, buy the stock when it is thought to be at its highest. It goes without saying that if the stock market price is lower than the discounted price you’ve been offered, it’s perhaps more prudent to not exercise the option or to wait until the market price rises.

3. Reduce your lock-in period

Some companies may insert a lock-in clause that would prevent you from selling your shares in the market for a certain amount of time. Once again, this is to ensure you don’t immediately cash out and leave the firm. But it is in your best interest to reduce the lock-in period so that you’re in total control of your decision-making.

4. Selling at the right time

Selling your shares exposes you to ESOP taxation in terms of capital gains. Sell your shares at least after a year to avoid short-term capital gains taxation. Also, keep your overall gains under Rs. 1 lakh for the year to avoid long-term capital gains tax.

Conclusion

While ESOPs are inherently ‘risky’ because they deal with the stock market, you shouldn't be concerned as long as your company is doing well and the fundamentals are strong. Whether you’re better off choosing cash over ESOPs is an entirely personal decision, taking into account your need for cash at the moment, your financial strength, and your lifestyle choices. You must also have a fair idea of the prospects of your company before committing to it. If you do decide to use ESOPs, make sure you schedule your moves carefully and are familiar with ESOP taxation regulations so you know precisely how much money you've made.

Also Read: All Your Need To Know About ESOPs