6 Different Types of ESOPs

Employee stock ownership plans (ESOPs) have become increasingly popular in India over the past few years. They are seen as an effective way for companies to attract and retain talented employees by offering them an ownership stake. ESOPs are an extremely good option for companies to reward their employees and reward them for their hard work and commitment. This blog post will provide all the information you need about the six different ESOPs available in India.

Employee Stock Option Scheme (ESOS)

Definition: Employee Stock Option Scheme (ESOS) is a type of employee benefit plan that allows employees to purchase a certain number of company shares at a fixed price, usually over a period of time.

Key Features: ESOS plans can include options for stock ownership, vesting periods, and set expiration date. Employees are also typically able to exercise their options within the specified period.

Benefits: ESOS offers numerous benefits to both employers and employees. It provides employers with a great way to retain and reward their most valued employees while allowing employees to acquire an ownership stake in the company.

Drawbacks: One of the drawbacks to ESOS is that it can be difficult to monitor and manage. Also, depending on the company’s performance, employees could lose money if the stock price falls after they exercise their options.

Suitability: ESOS is suitable for companies looking to motivate and reward their employees with equity stakes in the business.

Applicability: ESOS plans can apply to any company listed on a recognized stock exchange with a minimum net worth of Rs. 5 crores.

Requirements: Companies must comply with regulatory guidelines for ESOS plans, including the need to disclose all related information to employees on time. They must also meet certain conditions, such as a board-approved ESOS plan.

Employee Stock Purchase Plan (ESPP)

Definition: An employer-sponsored program known as an Employee Stock Purchase Plan (ESPP) enables employees to buy company shares at a discounted price over time.

Key Feature: One of the key features of ESPP is the ability to purchase shares of the employer’s stock at a discounted price. Employees can make payroll deductions from their wages, which will then be used to buy shares of the employer’s stock.

Benefits: An ESPP offers employees an incentive to stay with the company. It also allows employees to become shareholders, giving them a sense of ownership and alignment with the company’s vision and goals. Additionally, ESPPs offer tax benefits as the taxes are deferred until the employee sells the shares.

Drawbacks: The biggest downside of an ESPP is that it ties employees to their employers. If an employee leaves the company before they’ve had the chance to purchase the stock, they will forfeit their chance to do so. Additionally, the value of the stock may not increase or remain stable during the time of the ESPP, resulting in financial losses for the employee.

Suitability: ESPPs are suitable for companies that want to incentivize employees to stay with the company for longer and reward them for their loyalty. It is also beneficial for companies that want to give their employees a sense of ownership and alignment with the company.

Applicability: ESPPs apply to both publicly and privately held companies. The company must create an official plan document and submit it to the Securities and Exchange Commission (SEC) for approval.

Requirements: These include minimum participant eligibility requirements, offering periods, and other administrative requirements. Companies should consult with a qualified professional to ensure all requirements are met.

Restricted Stock Units (RSU)

Definition: Restricted stock units (RSUs) are a type of employee stock-based compensation granted to employees as part of their salary and vesting at a certain point in the future, usually after a vesting period or when certain performance goals are met. RSUs are considered a form of deferred compensation since the employee does not receive the value of the shares until they have vested.

Key Feature: Unlike stock options, which require employees to exercise their options to receive stock, RSUs provide an actual grant of company stock deposited into the employee’s account upon vesting.

Benefits: A key use of RSUs is that they can provide employees with immediate access to company equity without investing any of their own money or resources. This can be especially beneficial to employees not in a financial position to purchase shares on the open market. Additionally, since the value of RSUs typically vests over time, they can help incentivise employees to stay with a company for longer.

Drawbacks: The main drawback to RSUs is that they can come with significant tax consequences. For example, when an employee’s RSU vests, he or she will generally be subject to taxes at the prevailing capital gains rate. Additionally, since RSUs are typically taxed at vesting, there may be some uncertainty about how much taxes the employee will owe at that time.

Suitability: RSUs are generally most suitable for larger companies with the resources and infrastructure to administer the plan. Additionally, due to the complexity of administering RSUs, smaller companies may not find it cost-effective to offer this type of plan.

Applicability: Since RSUs can be expensive and difficult to administer, they may not be appropriate for companies with limited resources or employees across multiple locations. Additionally, RSUs may not be appropriate for companies looking to offer their employees a significant amount of equity.

Requirements: Companies considering offering RSUs must ensure they have the necessary resources and infrastructure to administer the plan effectively. They should also have an experienced legal team on board to ensure the plan complies with all applicable laws and regulations. Additionally, the company must have sufficient funds to cover issuing and transferring the shares.

Restricted Stock Award (RSA)

Definition: A Restricted Stock Award (RSA) is an employee benefit program in which employees are given company stock with certain restrictions, such as a vesting period, to promote loyalty and longer-term employment. An RSA is generally offered to executives or key employees as an incentive. 

Key feature: The key part of an RSA is that it vests over some time, meaning the employee cannot sell the stock until after it has vested, often at the end of a specified number of years. 

Benefits: The benefits of an RSA include the potential to acquire stock at a discounted price

Drawbacks: include the potential for the store’s value to decrease before it vests. 

Suitable: An RSA is ideal for businesses that reward key employees with equity incentives. 

Applicability: RSAs apply to all types of companies, but they may be more beneficial to privately held companies where the stock is not publicly traded.

Requirements: At the same time, the conditions typically include a vesting schedule, a shared pool, and registration with a regulatory body.

Stock Appreciation Rights (SARs)

Definition: Stock Appreciation Rights (SARs) are employee benefits where employees receive the right to receive cash or stock based on the increase in the value of the company’s stock. This allows employees to share the company’s success without owning the stock. Companies typically grant SARs to key employees as an incentive for future performance.

Key features: The key features of SARs include no up-front costs, no dilution of existing shareholders, and the ability to set vesting conditions that are more flexible than those of other equity incentive plans.

Benefits: Employees can receive cash or equity based on the company’s stock value increase without having to buy and own the stock. SARs also enable employers to retain key employees while avoiding some costs associated with other forms of equity compensation.

Drawbacks: SARs have potential disadvantages, such as a lack of liquidity, because they cannot be sold or transferred. They also have a limited life span and must be exercised within a certain period.

Suitability: SARs may be suitable for companies that have limited resources but still want to offer stock-based incentives to key employees.

Applicability: Companies may grant SARs as either a standalone plan or as part of a broader employee stock ownership plan.

Requirements: Employers must comply with IRS and SEC regulations when granting SARs. The exercise price must be determined at the time of grant and may not be lower than fair market value.

Phantom Stock Option Plans (PSOPs)

Definition: Phantom Stock Option Plans (PSOPs) are a type of employee benefits program designed to reward employees with stock-like awards without actually issuing shares of the company’s stock. The award is usually based on the company’s performance and is typically paid out in cash or its equivalent.

Benefits: PSOPs have advantages over traditional stock options, such as lower costs and easier administration. Since there’s no actual stock issuance, there’s no need to register or report the awards to the SEC. In addition, the employer is not responsible for withholding taxes on the phantom awards.

Drawback: The biggest downside to PSOPs is that they don’t provide the same long-term benefits as traditional stock options. Because the phantom awards are based on the company’s performance, employees don’t have an ownership stake in the company. As a result, they don’t get any benefits of owning actual shares, such as voting rights or dividend payments.

Suitability: PSOPs may be suitable for companies that want to reward employees without incurring the costs and administrative burden associated with traditional stock options. They may also be attractive to companies that want to provide their employees with incentives but don’t want to issue actual shares of their stock.

Applicability: PSOPs may reward various employees, from executives and senior managers to rank-and-file workers. They can also incentivise employees to reach certain performance goals or stay with the company for a certain period.

Requirements: To implement a PSOP, companies must establish an agreement with their employees and ensure that it complies with all applicable laws and regulations. Companies should also consult with tax and legal professionals to ensure that the plan meets their needs and is properly administered.

Live Example of ESOPs

Microsoft, a corporation that trades publicly, has been providing ESOPs (Employee Stock Ownership Plans) to its staff since the 1980s. Microsoft’s ESOP is a stock purchase scheme that enables workers to purchase company shares at a reduced rate. The program is available to all workers regardless of their position or rank within the organization. Employees who participate in the plan have the option to retain the shares they purchase or sell them at a profit.

Publix Super Markets is a chain of grocery stores that is largely owned by its employees through an ESOP, which was created in 1974 and currently owns approximately 14% of the company’s stock. After completing a year of employment, Publix workers are eligible to take part in the ESOP, and the firm contributes a portion of each employee’s income to the scheme each year. Employees who leave the company or retire can sell their ESOP shares back to the firm.

Conclusion

Employee Stock Ownership Plans (ESOPs) are a great way for businesses to provide their employees with an ownership stake in the company. Understanding the differences between each option and how they will affect the company and its employees is important before deciding which one is best suited for the business’s needs. By choosing the right ESOP plan, companies can ensure that they are providing their employees with a meaningful form of compensation while also giving themselves an ownership stake in the company’s success.

Frequently Asked Questions

Are there any tax implications associated with ESOPs?

Yes, there are certain tax implications associated with ESOPs. The tax liability depends on the type of ESOP and its terms and conditions. Generally, employees need to pay short-term capital gains tax on their gains from exercising stock options.

What is the process for setting up an ESOP? 

The process includes selecting a plan type, drafting a trust agreement, obtaining necessary approvals, and setting up the ESOP fund.

What are the risks associated with investing in ESOPs?

Investing in ESOPs carries certain risks, such as the risk of fluctuating stock prices and the risk of losing money if the company’s stock price decreases. Additionally, there may be restrictions on when you can sell your stock and limitations on how much you can receive in dividends.

How long does it take to set up an ESOP?

It depends on factors such as the complexity of the plan, the number of participants, and the resources available. Generally, it takes several months to complete the setup process.