ESOPs Explained: Decoding The Process

  • Written Written by Team ESOP 21 September 2023 | 4 min read
  • Editor's Note :

    Decoding the ESOP Process, which delves into the world of Employee Stock Ownership Plans (ESOPs). This post offers valuable insights into the ESOP process and its implications for businesses and employees

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Introduction

"The way to develop the best that is in a person is by appreciation and encouragement." - Charles Schwab

ESOPs are no longer something new nor something that companies are just understanding, instead, they have been established as a method to attract and retain talent while providing wealth creation to them. By giving shares that could provide remuneration surpassing their package – providing the ultimate source of motivation and encouragement.

If you want to know more about the benefits, drawbacks, or the process of establishing ESOPs, you check out our other blog here: ESOPs Unravelled

ESOPs Key Terms: A Recap

Though we’ve spoken a lot about the terminology and the process of ESOPs in case you are new to this, here’s a short recap:

ESOPs: In the Harry Potter world?

For Easier Understanding, let’s Take This in the Wizarding World.

Instead of ESOPs, if they have MESOPs – magical ESOPs, taking them to be based on the house points – but now individual points. Students accumulate House Points through various activities, such as earning high marks in their magical classes, displaying acts of bravery, showing kindness, or contributing positively to the Hogwarts community. This is like giving ESOPs or stock options based on the performance or milestones achieved by employees.

These points are accumulated over the years, giving them specific points per year – which is similar to the vesting period. Once this period is over, you can unlock the power to get access to the “room of requirement”, based on the points accumulated you can get special enchanted objects or access to certain magical experiences. In the real world, this would be equivalent to getting monetary benefits.

Overseeing all these operations would be a "Magical Council of Professors", who oversees the allocation and distribution of points, ensuring that it aligns with the values and principles of the school (which would be a combination of HR and finance teams) in the real world.


Now let’s back to reality and understand the journey and process of ESOPs to know what happens.

The 5-Step Process of ESOP Allocation

This is a comprehensive 5-step process that most companies follow for creating, allocating, and distributing their stock options.

Design and Establishment

This initial stage involves the planning and creation of the ESOPs. The company's management, with the help of advisors and consultants, designs the ESOPs to suit the organization's specific goals and needs. They determine the eligibility criteria, contribution levels, vesting schedule, and the mechanisms for distributing the ESOP benefits to employees. Legal and regulatory requirements are considered during this stage to ensure compliance.

This phase involves asking and answering questions involving the grant of stock options like:

Communication and Participation

Once the ESOP Pool and the ESOPs that have been decided to be allocated are decided, the company communicates the plan to its employees. It is crucial to ensure that all eligible employees understand the ESOP, its benefits, and their rights and responsibilities within the plan. Effective communication fosters employee participation and engagement with the ESOP.

In this step, ESOP Grant letters have to be provided for the employees, and signed letters have to be taken. With Vega Equity, you can streamline to process of sending ESOP grant letters to hundreds of people in seconds. With dashboards, employees can view the exact status of their stock options clearly.

Accumulation and Vesting

During this stage, employees start accumulating their shares in the ESOP. Vesting is a critical aspect of this stage, determining when employees become entitled to the ownership of the shares. Vesting schedules may vary, but common practices include graded vesting over a certain number of years or a cliff vesting where full ownership is granted after a specific period. The things to be considered in this stage are:

Exercise and Cashflow

During this period employees acquire the shares they have earned through the vesting period. The specific steps and procedures for exercising ESOPs may vary depending on the ESOP plan's design and the company's policies. This is also the point where there is a difference in communication between private and listed companies.


There would be a need to pay tax based on the difference in share price. We’ll talk about the taxation of ESOPs in a different article. Please note generally, the liquidation of ESOPs is linked with one or more of the following events

ESOP buyback
Secondary sale
Pre-IPO Trust
IPO, etc.

Exit and Distribution

This is the last stage which comes into play when an employee leaves the company due to retirement, termination, or any other reason. At this point, the employee's vested shares in the ESOP are distributed to them according to their policy. The distribution can take various forms, such as cash payments, stock transfers, or a combination of both, depending on the plan's provisions and the circumstances of the employee's departure.

Want More Elaborate Steps?

These are the most common steps that you can find for an ESOP process. But if you to take a look at our 11-step detailed process – then you should check out our eBook - A comprehensive guide for ESOPs implementation.

If you are a part of the HR or finance teams you should check it out.

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