Can You Make Wealth Through ESOPs?

Employee Stock Ownership Plans, or ESOP, are increasingly being offered by Indian start-ups and established corporates as a way to reward and retain talent. They give employees a chance to own a part of the company, aligning personal financial growth with the organisation’s performance. With the right understanding and approach, ESOPs can become a valuable tool for building wealth.

How ESOPs work

An ESOP allows a company to grant its employees the right to purchase its shares at a predetermined price, often lower than the prevailing market value. These rights are tied to a vesting schedule, which means employees need to stay with the organisation for a set period before they can exercise the options. Once vested, the employee can buy the shares and either hold them for long-term growth or sell them, depending on market opportunities and company policy.

Wealth creation potential

The primary wealth-building opportunity from an ESOP comes from the appreciation of the company’s share price. If the market value rises above the exercise price, the difference represents a gain for the employee. For example, if an employee has the right to buy shares at Rs. 100 each and the market price rises to Rs. 300, they stand to make a profit of Rs. 200 per share on sale. High-growth companies, especially those approaching IPOs or buyback events, often provide substantial returns to ESOP holders.

Benefits for employees

• Ownership stake: Employees feel more connected and motivated, knowing their efforts contribute to both the company’s and their own financial growth.
• Potential for high returns: Successful companies can deliver returns far greater than traditional savings instruments.
• Tax advantages in certain scenarios: Capital gains taxation may be more favourable compared to salary taxation, although professional guidance is important.

Risks and considerations

ESOP values are dependent on company performance, so there is no guaranteed return. Unlisted company shares may have limited liquidity, meaning employees might have to wait for a buyback or listing to sell. Tax liabilities can arise at both exercise and sale stages, so careful planning is needed to avoid unexpected costs.

Maximising ESOP benefits

To make the most of an ESOP, employees should:

• Understand the vesting schedule and lock-in conditions.
• Keep track of company performance and market position.
• Seek expert advice on tax planning and selling strategies.
• Avoid over-concentration by diversifying other investments.

Conclusion

An ESOP can be a powerful wealth creation avenue for employees in growth-oriented companies. While it carries certain risks, informed decision-making, patience, and strategic planning can help employees unlock significant long-term financial benefits from their stock options.