7 Mins

When you join a company, your salary may not be the only compensation you receive. You will also receive some perks, vacation days, and possibly some company shares. Your salary may include some type of equity, most likely stock options (ESOPs) or restricted stock units (RSUs), depending on the company for which you work. Both restricted shares and stock options are kinds of equity remuneration but have their own set of restrictions. The article highlights the key difference between RSU Vs ESOP.

Scripbox Recommended Goals

Plans that will help you to achieve your life goals across multiple time frames.

What is a Restricted Stock Unit (RSU)?

Restricted Stock Units (RSU) are more straightforward than stock options because no transactions or stock pricing are involved. Instead, the corporation just pledges to give the employee company stock when a certain condition is met. For example, either for achieving performance conditions or remaining with a company for a specified period of time companies issue RSUs.

An employee obtains company stock from the organization, subject to a vesting period. A vesting period is the amount of time an employee must wait before claiming the company-allocated shares. For example, suppose a company offers 500 RSUs to an employee with a four-year vesting period. In that case, the employee will be eligible to receive those 500 shares from the company only after completing four years of service.

Furthermore, on meeting the requirements, the company will grant RSUs in shares of stock or the cash equivalent depending on the value of the stock at that time. Thus, the employer may stipulate whether an employee receives genuine shares of stock or a cash equivalent. Or, the decision may be left to the employee.

RSUs have been proved to be an excellent method for corporations to reward employees. RSUs are also a relatively effective method for employers to retain their staff over the long run. From the above example, if the employee leaves the firm before the vesting period, they will not get any shares.

Some companies distribute RSUs to their employees in instalments, say, 25% per year. Let’s say a company issues 500 RSUs with a yearly vesting requirement of 25%. So, end of the first year, the employee gets 125 shares (25% of 500 RSUs). Similarly, 125 shares at the end of the second, third and fourth year.

What is an Employee Stock Option Plan (ESOP)?

Employee Stock Option Plan (ESOP) are typically granted to employees, and they hold the right to purchase the stock at a future date for a specified price. The company determines the price when it grants the stock options. You don’t have to purchase the shares, but you have the option to do so if you believe it would be prudent.

As part of compensation or an employee retention strategy, the company offers stock options to employees to purchase the shares in the company. Usually, ESOPs are accompanied by a vesting schedule. A vesting period is the time duration for which you must work at the company (typically one year) before you are eligible to acquire the stocks. This is to prevent short-term employees from acquiring potentially valuable firm equity.

One of the biggest advantages of stock options is the ability to purchase shares at a price that may be significantly lower than the stock’s market value as on the vesting date.

The stock options may vest on a predetermined schedule. For example, you may be able to exercise 500 shares a year for a total of 2,000 shares. Also, there may be an expiration date after which you cannot exercise stock options.

For example, an employee gets 1,000 ESOPs (on June 1st 2017) with a five-year vesting period at a price of INR 500. On June 1st 2022, the employee has an option to exercise the stock option. If the current market price is greater than INR 500, the employee makes profits. In case the CMP is lower than INR 500, the employee can choose not to exercise their option or wait until the prices increase.

Difference Between RSU and ESOP

Basis of DifferenceRSUESOP
ShareStocks are granted.Stocks are purchased.
VariationsRestricted Stock Units and Restricted Stock AwardsNon-Qualified Stock Options (NSO) and Incentive Stock Option (ISO).
Grant DateRSUs can be issued after the issuance.ESOP can be issued any time after the issuance.
Exercise PriceNonePrice is fixed when ESOPs are issued.
ActionUpon vesting, employees need not do anything. The shares are deposited into the brokerage account.Employees must take action to exercise their options.
Voting RightsThey don’t have voting rights.Enjoy voting rights once the employee exercises their option.
Shareholders RightsRestricted rights of the shareholders.Enjoy full shareholders’ rights only after the employee exercises their option.
DividendsDo not get dividends.Get dividends.
Settlement After the Vesting PeriodIf the conditions are met, the offered shares are settled. However, you can defer the settlement for tax benefit purposes.It depends on the employee’s discretion to exercise their ESOPs or not.
Mode of SettlementCash or StockStock
RiskLess risky as employees get the share at fair market value.Comparatively more risky, as the stock price may be equal to or less than the exercise price.
TaxationTaxes depend on the holding period after vesting.
Listed Companies: STCG tax of 15%, if holding period less than one year. No tax in case the stocks holding period is more than one year.
Unlisted Companies: If the holding period is less than one year, the capital gains add up to the taxable income and are taxable as per the income tax slab rate.
If the stock holding period is more than one year, the gains are taxable at 20% with an indexation benefit.
Taxes depend on the holding period after vesting.
Listed Companies: STCG tax of 15%, if holding period less than one year. No tax in case the stocks holding period is more than one year.
Unlisted Companies: If the holding period is less than one year, the capital gains add up to the taxable income and are taxable as per the income tax slab rate.
If the stock holding period is more than one year, the gains are taxable at 20% with an indexation benefit.
Popular AmongMore mature and later stage companies.Early stage and high-growth start-ups.

RSU vs ESOP – Which is Better?

Stock options and RSUs have their own pros and cons. The choice between the two depends on how you believe the company will perform in the future.

Companies grant RSUs and offer them to their employees without requiring them to purchase the stocks. Furthermore, employees can choose to take them in the form of shares or cash.

On the other hand, in stock options, companies offer the option to their employees to purchase shares at a defined price and time. Also, in accordance with a vesting schedule, a particular number of shares may become available each year over a period of years.

At some time during the vesting term, stock options are only valuable if the market value of the underlying shares is greater than the grant price. Otherwise, you would be paying more for the shares than their current market value.

RSUs, on the other hand, are purely profitable because you do not have to pay for them. Companies typically provide fewer RSUs than regular stock options for this reason.

If you must pick between stock options and RSUs, the choice depends on your willingness to take a risk. Say you are willing to risk and are confident that the share price will rise sufficiently to make stock options viable. Or whether you prefer the safer option of RSUs.