Many companies, to retain employees, offer stock options as part of their compensation package. Some of the terms that you will hear around this are RSU, ESOP and ESPP. The concept is similar, but there is still some difference between them. So, if you have your doubts and are confused about how these options work in practice, this article will help you.
Let us see each of these in detail and then compare them on various fronts.
Employee Stock Option Plan (ESOP)
As the name suggests, in this share compensation system, the employee has the option to purchase shares of the employer, at a pre-determined price, but at a future date.
For example – Let’s say you join a company in 2022. Now the employer may offer your 10,000 ESOPs which vest when you complete 2 years in the company at a pre-decided price of Rs 100 per share.
So, if you remain with the company for 2 years, i.e., till 2024 and if the share price is Rs 175, you will get the option to purchase up to 10,000 shares at earlier committed price of Rs 100 and irrespective of the prevailing market price at the time.
So, you make a neat profit of Rs 75 per share compared to the market price of the share.
Generally, ESOP vesting also happens in tranches or blocks. For instance, you get 20% after, say, 1 year, then another 20% of the allotted shares after the second year and then, a larger chunk of 60 percent after, say, the third year.
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.
Let’s say you join the company at the start of 2022; your employer may offer you RSU of 5,000 shares that will start vesting 25 percent every year after completion of the second year.
So, this means that in the first tranche, you will get 25 percent, or 1,250 shares of the company in 2024. After that, you will get 1,250 shares in 2025, 2026 and 2027. If you stay in the company till 2027, you will get all 5,000 shares. If you quit in between, let’s say in 2025, then you lose out on the shares which would have vested in later years.
It’s like a promise by the company that if you show loyalty and remain working for long, you will keep getting shares of the company. Many times, RSU vesting is linked to performance metrics as well in addition to the vintage of the employee in the company.
Employee Stock Purchase Plan (ESPP)
Under ESPP, employers offer regular ongoing purchase of company shares at a pre-decided discount to the prevailing market price. It is like a sort of monthly SIP that the employee can do in their employer’s shares.
A company may allow you to invest 10-15 percent of your monthly salary via ESPP in company shares at a 20 percent discount. So, if you earn Rs 1 lakh monthly, then you can invest Rs 10-15,000 via an ESPP. And suppose the company share is trading at Rs 200, then you get it at a 20 percent discount, i.e., at Rs 160 per share.
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 as income and taxed accordingly.
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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. 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.
The risks of ESOPs
On the flip side, your risk as the ESOP holder kicks in if your company’s shares aren’t doing that well on the stock exchange. If that happens, you may regret holding stocks that you received from such an employer via RSU, ESOP or ESPPs.
Many times, due to the gradual accumulation of stocks via these plans, the employer stock becomes the biggest holding for many people. This is a huge concentration risk from an investment perspective. People avoid selling such stocks as they see the potential for future growth.
But it’s always a good idea to reduce the allocation to an employer’s stock if it goes beyond a threshold. Talk to your investment advisor for help in such cases.
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