An ESOP grant gives employees the option to buy shares at a previously defined price. This exercise price is the price at which the holder of stock options has the right, but not the obligation, to purchase vested options within the term period. This is also called strike price in US.
Basically, an employer and employee agree on ESOP terms on the grant date. Once the employee has fulfilled the conditions or the relevant time period has elapsed, ESOPs are vested. Now the employee may choose to exercise these options i.e. to buy these options. Some time is given and within this time period, the employee needs to exercise his/her options. Once the employee decides to buy, stock options are allotted at an exercise price which is usually lower than the Fair Market Value (FMV) of the stock. An equity option gets its value from the difference between the fixed exercise price and the FMV of the underlying security.
The exercise price of options can be anything that is chosen by the company while giving out the ESOP grant letter. Some startups choose the exercise price as a nominal amount (say 10 Rs) while some startups choose the exercise price based upon the last round valuation of the company. If at a later date there is a liquidity event, which gives the options some real value, then it could be argued that the difference in the value of the company from when the employee joined, to the liquidity event, represents the added value to the company to which he/she contributed.
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