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Designing a Phantom Option Plan for an NBFC
ESOPs are setting new market trends daily, and more and more companies and startups are choosing it as their preferred incentive-sharing method. In this wake, it is very important for every employee to understand the fundamentals of ESOPs and all the technical terms related to it to be able to exercise their ESOPs wisely.
Companies now reward talent with ESOPs, reserving 10-25% equity pools to align employees with growth. But most employees never fully understand what they hold. Equity jargon, piles of documents, and nobody really sits down to explain it to you. Knowing the basic terminology is what separates an employee who exercises their ESOPs wisely from one who doesn't.
In this article, we will introduce common terms used in ESOP terminology to help you understand ESOPs and how to exercise them in a simplified manner.
Below are a few important ESOP terms you should know:
Employee stock option plan refers to an employee benefit plan under which a company grants stock options to its employees. Companies use ESOPs to attract and retain talent by allowing their employees to purchase shares of the Company at a price fixed on the date of grant.
Employee: The term "employee" refers to a permanent worker for a corporation who may be based in India or elsewhere. Additionally, this would apply to any full-time independent director as well as any subsidiary or associate company's staff.
It refers to the overall expense an employee causes the business due to his salary, which includes his base pay, deferred compensation, bonus, and any form of commission. However, employee compensation does not include the fair value of options granted under employee stock option plans. Additionally, the discounts at which ESOP employee shares are offered are also not considered to be a portion of employee pay.
The employee stock options pool is the total number of shares reserved for the company's employees. It's part of the ESOP scheme document and approved by the shareholders. Typically, companies set aside 10-25% of equity for the ESOP pool. Phantom stocks or SARs are the best choice, where a Company wishes to offer employees with rewards that are based on merit or some other discretionary basis - the benefit being since they are given in cash for the shares and no ownership control is given to the employees, handling of these options becomes easy for the owners.
When a company adds more shares to the ESOP pool, it is known as expanding the pool. Companies typically broaden the pool to give more stock options to the existing employees or to make critical hires.
Vesting is the process by which the Option holder earns full rights to their options to be converted into stocks. This can happen by way of meeting certain time-based Vesting conditions or other performance-based milestones. Only Vested Options can be exercised to become stocks. This prevents the employees from joining a company, purchasing stocks at a discounted rate, and leaving the company. Otherwise, it defeats the purpose of ESOP as a mechanism to retain employees. Vesting distributes the number of shares that employees can purchase at a time, which they have been granted.
There are two main types:
Exercise is the process of converting an option into a stock. This can only happen once the vesting period is complete and the exercise price is paid.
Exercise period is the period during which an employee can buy the vested stock options from the company. If an employee fails to purchase the vested stock options during the exercise period, they lapse and are no longer available to the employee to exercise.
Exercise date is the date on which an employee exercises options and converts them in the company shares. On that date, you pay the exercise price and convert your vested options into actual company shares. It must fall within your exercise period.
It is the price at which employees can purchase the shares once they get vested. Often, the exercise price is lower than the market price.
The strike price is the set amount you pay for each share when you exercise your options.
The grant price is the price of company shares locked in on the day you receive your options. It matches the strike price, you pay this exact amount per share when you exercise.
When an employee exercises his vested options, they have to pay tax on the exercise. In India, it is known as a perquisite tax. The exercise tax is calculated on the difference between the fair market value of the share and the exercise price of the option. Fair market value of the share is required to be determined by a merchant banker in India and an independent valuer in other countries.
Fair Market Value (FMV) for private companies is the estimated price at which a company's shares would be exchanged between a buyer and seller, both having reasonable knowledge of the facts and neither being under pressure to complete the transaction. Since private companies aren't publicly traded, FMV is typically determined through independent valuations like the 409A valuation.
Spread is the difference between the fair market value of the share and the strike price.
For example, if the share price is Rs 30 and the strike price is Rs 20, then the spread is Rs 10 (30 - 20). The higher the spread, the better the return employees get.
It refers to the document issued by the company while allotting stock options to its employees. Grant date means the date the Options are issued to the employee or contractor under the Offer.
Date before which an employee must exercise the options. After the expiry date, stock options lapse, and the employees lose the right to purchase the stock.
Typically, 10 years from the grant date if you stay employed. But if you leave the company, it shortens to 90 days (or whatever your grant letter says). Check your grant letter for the exact date
Post-termination exercise is the time window you get after leaving the company, whether you quit, get laid off, fired, retire, or your contract ends, to exercise only your vested stock options before they expire forever. Unvested options disappear immediately upon exit. Standard duration is 90 days (3 months) from your last working day, but your grant letter specifies the exact period under "Termination" or "Post-termination exercise period" section.
Understanding your ESOPs is not just a financial skill, it is a career skill. When you know what your grant letter actually says, when your options vest, what you will owe in taxes at exercise, and how long you have to act after leaving a company, you stop being a passive recipient of equity and start being an informed stakeholder in the business you help build.
The 17 terms covered in this article form the foundation of that understanding. A first-time ESOP holder decoding their offer letter and a seasoned employee approaching a liquidity event both have one thing in common, coming back to these fundamentals will always be worthwhile.
Before you exercise, take the time to review your grant letter carefully and never let your options lapse simply because the paperwork felt overwhelming. Your equity has real value, make sure you treat it that way.
Granting ESOPs is only half the job. The other half is making sure your employees know exactly what they own, when they can exercise, and what it is worth. Qapita helps you do that effortlessly. Book a demo today.
