Indian start-ups have recorded the highest ever ESOP buyback worth around Rs 3,000 crore ($440 million) in the year 2021, according to VC Circle. Flipkart, Browserstack, Swiggy, UpGrad, and Zerodha topped the charts in terms of buyback amounts. Last year, the wealth creation for employees via myriad stock participation programs hit an all-time high. It reaffirmed the faith of startup employees in wealth creation by joining the company at the right stage.
While these options are lucrative, it can be tricky to understand them. As an employee, your approach will naturally depend on exactly which form of equity sharing you are looking at. RSU requires a different treatment as compared to ESPP. ESOPs again change the range of choices you would have.
Below are some of the pointers to help you with company equity plan offerings.
1. Set calendars
It’s a good idea to set expiration dates and details of the vesting schedule in your calendar. This will help you know when to buy or offload shares. By doing that, you can also ensure sufficient liquidity to buy stocks under ESOPs or ESPP.
Also, be aware of the stock plan rules when you quit the company. Spreading sales across two financial years can save on taxes while working a few extra weeks might open up the vesting for the next year.
2. Understand tax implications
RSU – Since you don’t pay money to acquire shares, the entire share value will be treated as your income.
ESOP – ESOP has twin tax implications. One, at the time of allotment (when you buy that is) as ‘income from salary’ and later at the time of sale as ‘income from capital gains.’
In the case of the former, the difference between the exercise price and the market/FMV, as calculated on the exercise date, is treated as income. This is taxed as a prerequisite added to your salary income and taxed as per your existing tax band. One thing to note is that this will lead to a significant TDS impact which your employer will deduct from your salary as tax.
The second occasion is when you sell the ESOPs exercised. Here the difference between the sale price and FMV at the time of sale is treated as capital gains. The type of capital gains will depend on how long you have held the shares.
However, employees have an option to not exercise the option and remain free of tax liabilities.
You should also keep in mind that tax implications can be a lot more complicated than described here depending on where the company is domiciled. The structure of the company will also play a role. In most cases, it would be best to take the help of a tax expert to understand the specific nuances in your case.
ESPP – The difference between the discounted price and the market price/FMV is treated as income and taxed at the marginal rate.
3. Don’t ignore the risk
While equity plans from your firm have the potential to create immense wealth for you, there is the possibility of the organization not doing well in the future or even closing down.
In an ESOP, there is also the risk of the exercise price becoming out-of-the-money and practically worthless.
How much of your net worth do these stock options represent?
Employees, who have been with the organization for a long time and regularly participated in stock plans, are likely to have a sizable portion of its stock. Imagine, if the company goes belly up (like it happened with Enron), you lose not only your income stream but also your stock holdings become valueless.
So, minimize concentration risk by liquidating your single stock holding over a period of time. And reinvest it systematically in a portfolio of stocks/ equity funds that are in sync with your asset allocation needs.
So what’s the takeaway?
Do the necessary due diligence when you realise you have access to either RSUs or ESPPs or ESOPs. Diversify existing stock holdings by liquidating at least part of it over time and in favour of other investment options such as diversified equity funds or even direct equity of other listed companies. Ask your wealth manager or investment advisor to help you plan a diversification plan outside your RSU/ ESOP or ESPP.
This article was first published on 3rd April 2022, in the Times of India here.