“A great employee is like a four-leaf clover, hard to find & lucky to have” – Tammy Cohen
The word UNICORN is used to evoke a mental picture of a mythical horse in my mind. However, in the financial world, this word had a completely different meaning.
Here, unicorn is a term used to describe companies that crossed the $1 billion valuation. India being the 3rd largest startup ecosystem in the world, saw an increasing number of startups gaining the unicorn title.
By 2025, India is expected to have over 250 startups. With currently over 60K startups in India, the competition is fierce. Thus, retaining the best employees somewhat becomes a challenge to win!
Although retaining strategies like ESOPs started back in 1956, in recent years it gained major momentum. Companies started amplifying their strategies to retain their best employees by giving them multiple benefits a.k.a stock options!
Stock options provided by companies are segregated into 3 categories;
- ESOPs- (Employee stock ownership plan)
- ESPPs- (Employee stock purchase plan)
- RSUs (Restricted stock units)
Let’s take a closer look at this financial jargon!
Today, in this article, you’ll be explaining the difference between ESOPs, ESPPs & RSUs.
EMPLOYEE RETENTION STOCK OPTIONS
- Employee Stock Option Plan (ESOP)
As an employee benefit, Employee Stock Ownership Plans (ESOPs) make employees shareholders in their company. In the same way that publicly listed companies have stock options, startups also have share equity, and giving employees a share of the stock is an incentive to join. However, ESOPs are stock options.
There is no direct connection between them and the company’s stock. As the name implies, you have the option (and not the obligation) to buy the stocks at a predetermined price sometime in the future. In some cases, this could be as low as zero or at least deeply discounted.
For example – Let’s say you join a company in 2018 and your employer offered 2020 you 10,000 ESOP shares at a predetermined price of Rs 100 per share when you complete 2 years in the company.
Hence, if you stay with the company for two years, i.e., until 2024, and if the share price is Rs 1000, you can purchase up to 10,000 shares at an earlier committed price of Rs 100 irrespective of market conditions.
As a result, you make a nice profit of Rs 900 per share over the market price. You will thus, end up accumulating a wealth of 90 lakhs.
In general, ESOP vesting occurs in tranches or blocks. After one year, you get 25% of allotted shares, then another 25% after the second year, and then 60 percent after the third.
Also Read: Mutual Fund vs Stock Market Which is Better?
- Restricted Stock Unit (RSU)
In the case of RSUs, the employees get shares of the employer after a vesting period without having to pay practically anything from their pocket.
Employees are awarded restricted stock units when their employer presents them with one or more of the company’s stocks. If the stock is not within its vesting period, the beneficiary can sell it whenever they wish.
Assume you join the company in 2022; after the completion of the second year, the company may offer you 5,000 RSUs that vest 25 percent every year.
Consequently, you will receive 25 percent of the company or 1,250 shares in the first tranche in 2024. Following that, you will receive 1,250 shares in 2025, 2026, and 2027. If you remain with the company until 2027, you will get all 5,000 shares. If you quit in between, let’s say in 2025, then you lose the shares that would have vested later.
As a reward for loyalty and long-term employment, you will continue to receive shares of the company if you remain loyal. Often, RSU vesting is linked to performance metrics as well as the employee’s vintage.
- Employee Stock Purchase Plan (ESPP)
As part of the ESPP, employers offer regular ongoing purchases of company shares at a predetermined discount from the prevailing market price. Employees can invest in their employer’s shares through a monthly SIP.
ESPPs allow you to invest 10-15 percent of your monthly salary at a 20 percent discount in company shares. You can invest Rs 10-15,000 via an ESPP if you earn Rs 1 lakh monthly. You get the company shares at a 20 percent discount, i.e., 160 rupees per share if the share is trading at 200 rupees.
- Taxation of RSU, ESOP, and ESPP
At the time of Vesting/Purchase: In RSUs, you don’t pay anything to purchase shares. You just get it as part of the vesting schedule. So the market value of the shares at the time of vesting is considered income and taxed accordingly.
In ESOP (and ESPP), the purchase price (or discount) of shares is pre-decided. So, if the market price is higher than the exercise or purchase price on the day of purchase, then the difference between the two is treated as a perquisite and taxed.
At the time of the Sale: When you sell the shares that you received as RSU or ESOP or ESPP, the difference between the sale price and the vesting or exercise price is your capital gain.
The rate of taxation varies on your holding period (whether it’s short-term or long-term capital gain) and also on whether the company is listed in India, unlisted, or listed outside India.
As you may have realized, there are obvious benefits for employers to offer these stock plans to employees, especially when considering long-term investment planning. It helps and incentivizes retention of the workforce. For employees, it means they can participate in the company’s growth and benefit from big gains that can come their way due to stock appreciation.