January 23rd, 2024

A Comprehensive Overview of Different Types of ESOP

A Comprehensive Overview of Different Types of ESOP

In India, the Employee Stock Option Plan (ESOP) stands as a prevalent method to motivate employees. Under this stock option plan, a company offers employees the option to purchase its shares at a predetermined price. Employees can exercise this option by acquiring stocks based on the terms outlined in the agreement. ESOPs are primarily employed to reward and retain valuable staff, forming part of corporate buyback initiatives or broader strategies aimed at retaining key personnel. An ESOP, a company-sponsored employee benefit initiative, provides eligible employees the privilege to buy company shares at a predetermined price within a specified timeframe. The primary objective of ESOPs is to motivate and acknowledge employees for their commitment and contributions to the company's progress. By enabling employees to own a portion of the company, ESOPs cultivate a sense of ownership and loyalty within the workforce, fostering a deeper connection between employees and the organization.

Types of ESOP Popular in India

ESOPs have gained popularity in India, with six primary types that serve as effective tools for incentivizing employees in the country.

Employee Stock Option Scheme (ESOS)

The Employee Stock Option Scheme (ESOS) is a stock option plan that grants employees the voluntary right to purchase company shares at a predetermined value. This option is contingent on achieving specific performance goals over a designated vesting period. After the vesting period, employees can exercise their right to acquire the stocks at a fixed price, potentially below the market value set at the issuance. If employees choose not to exercise their rights, they expire without any compensation. Upon exercising, employees gain complete ownership, voting rights, and entitlement to receive dividends.

Employee Stock Purchase Plan (ESPP)

The Employee Stock Purchase Plan (ESPP) empowers employees to acquire company stock at a discounted or below-market price. Through periodic investments, employees can enhance their ownership stake in the company. With each investment, employees receive dividends, a share of the company's profits. This plan mirrors the opportunity for employees to acquire company stock similar to individual investors but with reduced risk. Employees can invest a fixed amount annually or through payroll deductions and the company may offer participation in the ESPP each year.

Restricted Stock Units (RSU)

RSU, or Restricted Stock Unit, is a form of ESOP where employees receive units that can be converted into actual stocks when certain restrictions, whether time-based or performance-based, are lifted. Typically granted for a specified tenure or upon achieving performance milestones, RSUs cater to executive employees, allowing them to hold company equity without voting rights or dividends until shares are issued after the vesting period. The number of awarded shares varies by executive position. However, as RSUs are non-liquid until conditions are met, they shouldn't be relied upon for emergency financial support.

Stock Appreciation Rights (SARs)

For companies aiming to provide stock benefits without the risk of shares being sold, Stock Appreciation Rights (SARs) are an ideal option. SARs afford employees the right to receive a gain in the company's stock price after a designated time has elapsed before the expiration date. Unlike traditional ESOPs, in SARs, employees don't pay an exercise price as no actual shares are granted; instead, they receive the increased value of the allocated stocks in the form of cash or shares.

Phantom Equity Plan (PEP)

PEP (Phantom Equity Plan) and SARs are commonly used interchangeably, yet they bear a subtle distinction. Similar to SARs, PEP doesn't involve actual stocks; it provides employees with the increased share value benefit. However, PEP operates more like a bonus than a stock option, resembling a reward awarded by companies to employees at a predetermined future date, contingent upon meeting specific conditions. Unlike SARs, PEP doesn't allow employees to exercise their benefits at will within a designated timeframe.

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