ESOP Financing

ESOP financing typically provides employees with a loan to cover the ESOP exercise price and related tax obligations, allowing early conversion of vested options without tapping personal savings. Lenders often take a pledge on the shares and structure repayment to match a future liquidity event. It can be an IPO, buyback or secondary sale, which can reduce monthly cashflow pressure. This option may help employees access the benefits of ESOP ownership while managing tax timing and liquidity risk.

Employee stock plans can be funded in different ways to suit company goals and participant needs. Common ESOP financing models include: 

Leveraged ESOP 

External debt is raised to buy company shares, which are then held in trust and allocated to employees over time. This model is typically used when immediate share purchase is required.

Non-leveraged ESOP 

The company directly contributes cash or its own shares to the plan, avoiding external borrowing while still allocating ownership to employees.

Combination ESOP 

This blends direct company contributions with borrowed funds. It can provide flexibility to scale allocations while managing cash flow.

Hybrid ESOP 

A mixed approach where cash and share contributions are used together, allowing custom allocation rules and funding arrangements under the ESOP structure.

Seller-financed ESOP 

Existing owners sell shares to the ESOP and finance the sale themselves, often receiving repayments from company cash flow or future liquidity outcomes.

ESOP financing solutions are designed to make option exercise practical and to align employee interests with company growth. Typical features and benefits include: 

• Funding for Exercise and Taxes

Loans or advances can cover both the exercise price and likely tax liabilities, reducing the need for personal cash. 

• Limited Recourse to Pledged Shares

Many ESOP loan structures focus security on the underlying shares rather than personal assets, which could lower personal financial risk. 

• Deferred Repayment Tied to Liquidity

Repayment might be structured as a bullet payment on an exit or buyback, which helps preserve employee cash flow. 

• Partial Funding Options

Financing is often available for a percentage of the shares’ fair market value, enabling selective exercise of vested options. 

• Improved Retention and Ownership

By enabling employees to convert options into ownership, ESOP funding may support retention and align incentives. 

• Customisable Pricing and Tenure

Interest rate and term can be tailored based on company valuation, credit risk and expected time to liquidity. 

Eligibility for ESOP funding is generally tied to the ESOP grant and the company’s policies. Common criteria include:

• Vested ESOPs

Applicants usually need vested options that are exercisable under the company’s stock plan. 

• Minimum Employment/Vesting Tenure

Lenders often look for a minimum service or vesting period to assess continuity and risk. 

• Company Permission

The employer’s ESOP plan must permit exercise, share pledge and any third-party financing arrangements. 

• Underwriting Checks

Providers usually evaluate company valuation, expected liquidity timeline and borrower profile before approving ESOP financing.

• Documentary Evidence

Grant letters, vesting schedules, identity proof and salary/employment verification are typically required. 

Employees who exercise and later sell ESOP shares usually face two distinct tax events: a tax on the benefit at exercise and a capital-gains tax on the eventual sale. The quantum and classification of tax depend on the timing of exercise and sale, the fair market value used, and prevailing tax rates including any surcharge and cess. 

During Exercise of Options 

At exercise, the difference between the Fair Market Value (FMV) of the shares on the date of exercise and the option exercise price is generally treated as a taxable perquisite and taxed as ordinary income at your marginal tax rate. In practice, companies or lenders who fund exercise often treat this amount as the immediate tax liability that the employee must account for. 

During Sale of Shares 

When you sell the shares later, the gain over the FMV at the time of exercise is normally taxed as capital gains. If the sale happens after a longer holding period and the shares are listed, the gain could attract long-term capital gains (LTCG) rates; if sold sooner, short-term capital gains (STCG) rates may apply. In ESOP examples, capital gains rates used often include surcharge and cess, so the effective rate could be different from the headline rate. 

Tax Savings Via Early Exercise of ESOPs 

Exercising early can sometimes reduce your overall tax because the perquisite taxed at exercise is calculated on a lower FMV at vesting. However, if you wait until near a listing the FMV and the taxable perquisite could be much higher. Early exercise may also start the holding period sooner, which could help qualify gains as long-term later. These effects depend on future company growth and applicable tax rules, so outcomes may vary. 

Here is a working example to illustrate how exercise and sale taxes might be computed. Note that the values are illustrative and include effective tax rates with surcharge and cess. 

Example 

• Quantity of shares: 30,000
• Exercise price: ₹10 per share
• FMV at vesting (exercise date if exercised early): ₹50 per share
• FMV at listing (sale reference): ₹500 per share
• Assumed marginal tax rate at exercise (including surcharge/cess): 39%
• Effective capital gains tax rate used in example (including surcharge/cess): 14.95%

Step 1: Tax at Exercise (if exercised at vesting)

• Per-share taxable perquisite = FMV at vesting − Exercise price = ₹50 − ₹10 = ₹40.
• Total taxable amount = ₹40 × 30,000 = ₹1,200,000.
• Tax at exercise = ₹1,200,000 × 39% = ₹4,68,000.

Step 2: Capital Gains on Exit (if sold at listing after exercising at vesting)

• Per-share capital gain = FMV at listing − FMV at vesting = ₹500 − ₹50 = ₹450.
• Total capital gain = ₹450 × 30,000 = ₹13,500,000.
• Capital gains tax = ₹13,500,000 × 14.95% = ₹20,18,250.

Hence, total tax (If exercised at vesting and sold at listing) 

= Tax at exercise + Capital gains tax 

= ₹4,68,000 + ₹20,18,250 

= ₹24,86,250. 

Now, consider the opposite: 

Tax If Exercised at Listing (no early exercise)

• Taxable perquisite at exercise = (FMV at listing − Exercise price) × shares = (₹500 − ₹10) × 30,000 = ₹14,700,000.
• Tax at exercise (39%) = ₹14,700,000 × 39% = ₹57,33,000. 

Potential Tax Saving from Early Exercise (vest vs listing)

• Tax savings = Difference = ₹57,33,000 − ₹24,86,250 = ₹32,46,750.

Note: These figures are illustrative. Actual tax liability could differ based on your marginal tax slab, applicable surcharges/cess, the tax treatment of pre-listing vs post-listing gains, and any future tax law changes. Always consider consulting a tax professional for personal tax planning.

Applying for an ESOP loan is usually a digital, document-driven process that aims for clarity and speed. Here are steps to apply for an ESOP loan on Bajaj Markets: 

• Step 1: Select ‘Apply Now’ at the top of the page to start the application.
• Step 2: Enter basic details such as your mobile number and date of birth.
• Step 3: After redirection, use the ESOP calculator to check your eligible loan amount.
• Step 4: Share your details through the form in the Connect section.
• Step 5: Receive a login link if your employer is on the approved list.
• Step 6: Complete digital KYC and access your sanction letter online.
• Step 7: Sign the loan agreement and submit the required documents.
   

The loan amount is disbursed after successful verification and completion of documentation.