6 Different Types of ESOPs – Employee Stock Ownership Plans
Employee Stock Ownership Plans, or ESOPs, are a type of equity financing that allows employees to own shares in the company they work for. ESOPs can increase motivation and productivity, improve retention, and provide financial security in retirement. However, there are different types of ESOPs with each one serving a specific purpose.
In this blog, we have listed down and explained 6 different types of ESOPs. Check them out.
Types of ESOPs
Companies can use several different types of ESOPs to fund themselves or reward and motivate their employees. Below are some of the most common types of ESOPs and their workings:
1. Employee Stock Option Scheme (ESOS)
This is the most common type of ESOP. An employee stock option scheme (ESOS) allows an employee the opportunity to purchase company shares at a predetermined price, typically below the market value.
These options are typically granted as part of a compensation package and are subject to certain performance goals over a set vesting period.
If the employee decides to exercise their option, they will become a shareholder with full ownership rights and the ability to vote and receive dividends. However, if the employee chooses not to exercise their option, they will not receive any benefits.
2. Employee Stock Purchase Plan (ESPP)
An employee stock purchase plan (ESPP) allows employees to purchase company stock at a discounted price and gradually increase their ownership stake in the business through periodic investments. ESPP allows participation in company profits as well, in the form of dividends.
It is a risk-free way for employees to purchase stock, as they can invest a set amount through payroll deductions or on an annual basis and participate in a company’s growth and prosperity.
3. Restricted Stock Units (RSUs)
Restricted stock units (RSUs) are a type of ESOP that allows employees to convert RSUs into real company stocks in exchange for a certain number of years spent working for the company or when specific performance milestones are achieved.
Once the vesting requirements are met, the employee is entitled to receive the shares. Do note these units do not come with voting rights or dividends until the vesting period is completed. These plans are typically in place to motivate employees and allow them to contribute to the company’s growth.
4. Restricted Stock Award (RSA)
Restricted Stock Awards (RSA) are a type of stock-based compensation that involves the grant of a specific number of shares to an employee, subject to certain restrictions. Typically, the restrictions on RSA shares are based on the vesting period and other performance goals.
One key difference between RSAs and Restricted Stock Units (RSUs) is with the latter, the employee does not receive any actual shares until the units vest and the restrictions on them lapse. However, both RSAs and RSUs can involve restrictions on when the employee can sell or transfer the shares, as well as other terms and conditions.
5. Stock Appreciation Rights (SARs)
Stock Appreciation Rights (SARs) are a type of ESOP that allows employees to receive a payment based on the appreciation of company stock over a certain period of time. Companies can use SARs to provide employees with stock benefits without diluting their equity. On the other hand, employees can benefit from such a plan by cashing in equity gains without taking on any downside risks.
SARs are typically granted to senior executives and other key employees as a way to align their interests with those of the company’s shareholders.
6. Phantom Equity Plan (PEP)
A Phantom Equity Plan may closely resemble a Stock Appreciation Rights Plan. A Phantom Equity Plan (PEP) is a type of ESOP that allows employees to receive a payment based on the value of the company’s stock without actually owning any shares. In other words,
PEP is an alternative to traditional employee stock option schemes, which provide employees with mock or “phantom” stock that tracks the value and performance of the company’s real shares. Under this arrangement, employees do not receive physical stock certificates but rather receive a financial payout based on the appreciation of the company’s shares.
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Final Word
There are several different types of ESOPs that companies can use, each with its own set of rules and characteristics. It’s important for companies to carefully consider which type of plan is right for their needs and to ensure that the plan is structured and administered in a way that aligns with their business goals and complies with relevant laws and regulations.
FAQs
Ans. No, ESOPs can be used by both public and privately held companies. However, it should be in accordance with the Companies Act, 2013, and the Companies (Share Capital and Debentures) Rules, 2014.
Ans. All employees, except for directors and promoters who hold more than 10% equity in the company, are eligible for the employee stock ownership plan (ESOP). Other restrictions may apply.
Ans. The value of the shares in an ESOP is typically determined by independent valuation firms that use models such as the Black-Scholes and other variables, including time value, interest rate, volatility, and more.
Ans. Yes, ESOPs are taxed differently than other types of employee benefits. The specific tax treatment depends on the type of ESOP, vesting period, gain amount, tax brackets, and more.
Ans. Yes, employees can sell the shares they receive through an ESOP once they have vested. However, there may be certain restrictions on when and how the shares can be sold and applicable laws and regulations.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
