In recent years, there has been a boom in companies, especially start-ups providing the option of equity participation to their employees. It is a great way to compensate employees and retain talent. Some of the popular company equity plans are ESOP, RSU, and ESPP. Considering how difficult it has become to acquire and retain talent, especially in technology, employers are using the entire gamut of options at their disposal.
Let’s understand how these options work.
RSU stands for Restricted Stock Units. Here, the employer offers shares to its employees without any conditions but with a vesting period. This approach is often employed by those firms whose shares are already listed on a stock exchange.
How does the vesting period work here is a common question by employees who have received such RSUs?
A company might allocate 10,000 shares after a vesting period of 5 years. After the vesting period ends, you get 10,000 shares. If you quit the organization earlier, you lose out. RSUs in general encourage employees to stay with the company for a longer duration.
One thing employees should note is that RSUs can also be allocated in a phased manner – say 2,000 shares in the first year, another 2,000 in the second year, and so on. However, most companies award this over a period of time and often in increasing amounts as the years go by.
These shares often come to employees at close to zero cost. They are a great tool for companies to hold back high potential resources.
Employee Stock Option Plan is perhaps the most publicised form of equity sharing among start-ups. In this case, the employee gets an ‘option’ to purchase company shares at a future date and at a predetermined price.
For instance, if someone joins a company on the 1st of April 2021, she might get an option to purchase 100 stocks at a predetermined exercise price of Rs 50 after a year. In this case, the vesting period is one year.
Only on completion of the vesting period, can she purchase 100 stocks of the company at Rs 50. This would be irrespective of the market price then. If she would have left before the end of the year, the options would have lapsed.
Often employees receive a “vesting period” schedule that informs them how many options are getting vested at different dates in the future. For the company, this is a great tool to align your incentives with the long-term objectives of the company.
If the shares are not listed, as is often the case, the employer provides an exit option by periodically buying back shares from its employees at Fair Market Value (FMV). This was seen in the case of some large private companies, such as Flipkart and Swiggy, recently.
ESOPs are allocated in blocks that get vested over a period of time. The most common vesting window is 4 years. A good vesting schedule is 25% vesting every year over a 4-year window.
For e.g., if 1000 shares are awarded a vesting schedule of 25% per year, the employee will have 250 shares vesting every year for the four ensuing four-year windows.
The employee gets an exercise period on the ESOPs i.e. a limited time window in which the employee can buy the shares at the agreed price. Good companies have a long exercise period, often extending to 10 years or more after the date of vesting.
This is another option that mostly listed firms use to reward or remunerate employees. Under Employee Share Purchase Plan or ESPP, the employee has the prerogative to purchase stocks at a discounted price.
The most common discount range is 10-20%. So, if a share is trading at 100 INR, an employee participating in ESPP can potentially buy the share at 80 INR if the applicable ESPP discount was 20%.
The organization usually gives a monthly purchasing window to the employees, while the overall purchase amount is linked to their salary (usually 10-15%). This is almost like running an SIP in your company’s stock. Supposing you earn Rs 20 lakh a year and plan to contribute 10% of your salary every month towards buying stocks. At the end of the year, you will be eligible to purchase Rs 2 lakh worth of shares at a discounted price.
It is important to understand your equity plan and the terms related to vesting. Also, you should get an idea of the tax implications on your equity plan after you decide to exercise it or exit the company. Company equity options can be intimidating, the best step here would be not to shy away and seek help from managers in your organisation.
This article was first published in The Times of India here on 24 March 2022