Employee Stock Option Plans (ESOPs) can be a great means for companies to cut cash costs and provide increased value to employees. However, do consider the pros and cons before opting for this method. Small businesses, especially those just starting out, may not have the means to pay high salaries to attract good employees. This, however, does not mean that they cannot acquire talented individuals.
ESOPs can be beneficial for both the employer and employee. For the former, it means maintaining liquidity, while for the latter, a reward for loyalty.
ESOPs explained ESOPs give employees a share of ownership in the company by giving them the option to purchase a fixed number of the company’s shares at a pre-determined rate, typically lower than the market price. On receiving the options, an employee must wait for a set amount of time known as the vesting period before he can exercise the right to purchase those shares.
In case the employee leaves or is asked to leave the company before he has exercised all his shares, it could create potential conflict. To avoid this, it is best to lay down the terms of usage in the ESOP agreement between the employee and the company. Here are a few things to consider before making a decision about ESOPs.
Pro: Cashless reward ESOPs can be a great option for companies to reward dedicated employees. An employee awarded with an ESOP can benefit monetarily if he exercises his shares well, while the company benefits because it does not have to make an outright cash payment to a talented employee in the form of a high salary.
Pro: Employment longevity Due to the nature of ESOPs, employees must wait until the vesting period is over before they can exercise their shares. Also, companies often offer stock options to employees with clauses of forfeiture or transfer restrictions unless certain conditions are met. These could include an employee staying with a company for a certain number of years or meeting certain pre-determined goals.
In any case, the employee has strong reasons to stay on with the company for a longer period, ensuring the latter doesn’t have to talent hunt after a brief period.
Con: Dilution of assets For employers, one of the cons of awarding ESOPs to employees is that it leads to dilution of the company’s shares when the employees decide to exercise their shares. Thus, while initially a great alternative to paying cash, ESOPs can eventually mean less income for the founders. However, for companies that are just starting out, ESOPs ensure positive cash flow.
Con: Potential to demoralize Just as ESOPs can prove to be a good incentive for employees, the flip side is that if the share prices of the company do not rise, employees may feel short-changed. If they are unable to reap the perceived benefits of owning company shares, they can be demotivated, leading to a drop in productivity.
To avoid this, it is best to set expectations straight right from the beginning, so that employees do not anticipate windfalls by way of share returns. ESOPs are popular among companies looking to keep their cash flow positive while providing lucrative benefits to employees with potential.
However, all aspects of an ESOP must be considered before determining whether or not this is a good fit for your company.