April 13, 2024
ESO

ESO (Employee Stock Option) is a type of equity compensation that is granted by the companies to the employees and executives. Instead of granting shares of stock directly, the company offers derivative options, employee stock options, on the stick instead. The stock options come in different forms of regular call options. Also, it gives the employee the right to buy the company’s stock at the fixed price for a limited time. The ESO is fully spelled out for an employee in an ESO agreement.

Generally, the biggest benefits of the stock option will be realized, if the company’s stock rises, over the exercise price. ESOs are issued by the company and can’t be sold, unlike the normal listed or Exchange-Traded Options. When the stock’s price increases above the call option exercise price, the call options are exercised and the holder gets the company’s stock at a discount. The holder picks to quickly sell the stock in the open market for a profit or hold onto the stock for over time.

employee stock options

Understanding ESOs

Corporate benefits for some or all employees can include equity compensation plans. These plans are known for delivering financial compensation in the stock equity. ESOs are a type of equity compensation a company offers. The other types of equity compensation include:

Restricted stock grants. These give the employees the right to get or receive shares, once certain criteria are attained like working for a defined number of years or to meet performance targets.

  • Stock appreciation rights. It provides the right to increase the designated number of shares value, such increase in the following:
  • Value is paid in cash
  • Company stock
  • Phantom stock. It pays the future cash bonus equally to the value of the defined number of shares. It has no legal transfer of share ownership that takes place. Although the phantom stock is convertible to actual shares if defined may trigger events.
  • Employee stock purchase plans. These plans give the employees the right to buy company shares, normally at a discount.

 

Types of ESO

The two primary types of ESO are:

  1. Incentive stock options. It is a qualified or statutory option, generally offered to employees and top management. It receives preferential tax treatment in many cases, as the IRS treats gains on ISO as long-term capital gains.
  2. Non-qualified stock options. It can be granted to:
    1. employees at all company levels
    2. board members
    3. consultants

It is also called the non-statutory stock option where the profits are considered ordinary income and taxed.

The stock options are a benefit incorporated with startup companies, which are issued to reward early employees when the company goes public. It is usually awarded by some fast-developing companies, as an incentive for employees working towards growing the company’s share value. The stock options will serve as an incentive for workers, which helps keep them stay with the company. The options will be canceled if the employees leave the company before vesting in.

The vesting period is the time employees must wait to exercise their ESOs. ESOs don’t have any voting or dividend rights.

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