The IPO fever is roaring, but do you know who is getting the most life-changing benefit?

Yes, you’re right! It’s their employees…!

But how….?

Let me explain this with the live example of Swiggy..

The employees who joined early in their organization received “ESOPs” (at a very low price) and It got listed they sold their shares and bagged huge profits!

But what are ESOP’s?

As per section 2(37) of the Companies Act, Employees Stock option plan are compensation schemes issued by a company to its employees, giving them the option ( the right, but not the obligation) to purchase a specified number of the company’s shares at a predetermined , often discounted price called the Exercise Price.

The primary purpose of an ESOP is to align the interests of the employees with the shareholders, fostering a greater sense of ownership and commitment to the organization's long term success.

These options are not granted immediately. They come with key conditions known as vesting schedule, which typically requires one or a combination of the following

• A minimum period of service (ex- a common schedule is 4 years with a 1 yr “cliff”- waiting period)
• Achieving specific individual or company performance targets( through time -based vesting is more common)

Once these conditions are met, the options are considered vested, giving the employee the right to covert them into actual shares.

Now, let us get some understanding of few key terms

• Grant Date- The date when the company officially gives us the right to buy a certain number of shares in the future

• Vesting period- The waiting time or the targets you must achieve while working for the company before we earn the right to buy the options

• Exercise Period - This period is the specific window of time during which an employee must pay the exercise price to purchase their vested options. If the options are not purchased(exercised) before this period expires , they will lapse (expire) and be permanently lost.

• Exercise Price- The Exercise Price is the fixed, predetermined, and often discounted amount an employee must pay for each share when they Exercise their vested option. This price is locked in on the date the options are Granted and does not change, regardless of how high the Market Price later becomes

• Market Price- The Market Price is the real-time, closing value of a share traded on a public stock exchange. This is the price at which we sell our shares to realize a profit. In the context of an IPO, the difference between your low Exercise Price and the high Market Price is where the huge wealth is created.

Accounting for ESOPs is dealt under IND AS 102- Share Based Payment.

Grant date	01-02-2021
Vesting period	01-02-2024
Vesting period	3 years
Market price on Grant date	150
Face value	1
Exercise price	60
Option value	100
No. of shares vested	2500
No of employees to whom shares options are granted	100

1. Accounting During the Vesting Period (Year 1 to Year 3)

Under Ind AS 102, the cumulative expense recognized at any point should reflect the best estimate of the options that will eventually vest. When an estimate changes (like an actual forfeiture), a "catch-up" adjustment is made in the current period's profit or loss

A. Year 1 (01-02-2021 to 31-01-2022)

• Let's assume the company initially estimated that 10% of employees (10 employees) would forfeit over the 3 years.
• Expected Vested options(at the end of Year 1): 10,000 options *90%= 9000 options
• Total estimated compensation expense: 9,000 options *100/option= $900,000
• Expense Year 1= Total expected expense* Years completed/total vesting period

Expense for Year 1= $ 900,000 *1/3 = $300,000.

31-01-2022	Employee Benefit Expense (P&L)	300,000
	Share-Based Payment Reserve (Equity)		300,000
	(Being, recognition of ESOP expense for 1st year based on expected vesting of 7,000 options)

Read more at: https://taxconcept.net/judgement/a-vested-right-accrues-in-favour-of-cwc-to-recover-rent-calcutta-high-court/

B. Year 2 (01-02-2022 to 31-01-2023)

The actual forfeiture of 30 employees (3,000 options) occurs during Year 2. This requires an immediate revision of the total expected vesting options. This requires an immediate revision of the total expected vesting options

• Revised Vested Opions( At end of Year 2): 100 employees- 30 forfieted = 70 employees.

70 employees *100 options/employee= 7,000 options.

• Revised Total Compensation Cost: 7,000 options *100/option=$700,000

We must now calculate the Cumulative Expense that should be recognized up to the end of Year 2, and then adjust for the amount already recognized

• Cumilative Expense Required= $700,000*2/3= $466,667
• Year 2 expense (Adjusment)= $466,667-$300,000= $166,666

31-01-2023	Employee Benefit Expense (P&L)	166,666.67
	Share-Based Payment Reserve (Equity)		166,666.67
	(Being, recognition of ESOP expense for Year 2, including the catch-up adjustment for forfeiture)

C. Year 3 (01-02-2023 to 31-01-2024)- Final Vesting

• Cumilative Expense for (3 years) = $ 700,000 *3/3 = $700,000
• Expense for Year 3= $700,000-$466,666= $233,333

31-01-2024	Employee Benefit Expense (P&L)	233,333
	Share-Based Payment Reserve (Equity)		233,333
	(Being, final recognition of ESOP expense for Year 3 and completion of vesting period)

2. Accounting Upon Exercise (Post 01-02-2024)

Assume all 7000 vested options are exercised

• Cash Received: 7000 options* 60( exercise price) = $420,000
• Par value of shares issued: 7,000 shares *$1 (par value)= $ 7,000

	Bank/ Cash	420,000
Date of Exercise	Share-Based Payment Reserve (Equity)	700,000.
	To Equity Share Capital( $1 Par value)		7,000
	To Securities Premium( Bal fig)		1,113,000
	(Being, exercise of 7,000 options and appropriation of SBPR balance)

“So, the next time you hear about an IPO, remember: the real headline isn't just the valuation, it's the quiet success of the employees whose ESOPs just transformed their lives.

The lesson?

In the world of startups, your salary is good, but your equity is everything. Invest your time wisely”

By kundana vedullapalli