An overview on the different types of ESOPs

Prabhat Nigam

15 Apr, 2022

In India, there is no uniformity as to the type of ESOP plan or scheme. There is also no set criterion whether ESOPs will be awarded on sweat equity basis or for-cash basis. Usually, companies in India adopt the route of directly implementing stock option plan or they implement through ESOP trusts. Normally, the vesting period in India for a company ranges from 4-6 years and the grants are made on a yearly basis. In the following discussion, attempt has been made to identify different Types of ESOPs that the companies in India adopt.      

What are the different types of ESOPs in India?

Following are the different types of ESOPs that have been adopted by Indian companies:

1. Employee Stock Option (ESOP) Scheme: Under an ESOP scheme, the employees are given a right to purchase stocks from the company at pre-determined price. Such scheme only confers a right and not an obligation on the employee to purchase the stock options. Granting of stock options is subjected to certain vesting conditions such as continuous employment over a period of time. This can also include performance up to certain scale. Once vesting period has passed, the employee is given the option to purchase the stocks from the company at a pre-determined price. In some cases, companies provide loans to the employees for this purpose. In this kind of ESOP, the employee upon exercising of such right becomes the shareholder of the company.

• Employee Stock Purchase Plan (ESPP): An ESPP allows the employees of the company to directly purchase the stocks from the company. The purchase price is mostly lower than the fair market value when such grant is made or exercised by the employee. ESPP^[1] lists down the conditions, date and price at which the employees are entitled to purchase the stocks. In ESPP, the employee becomes the shareholder of the company on the date the employer makes a purchase of the shares. In certain cases, the companies even extend loans to their employees to purchase shares pursuant to EPSS.

• Restricted Stock Award (RSA): RSA plan is also one of the types of ESOP plans where the employee receives a certain number of stocks subject to certain conditions. In RSA plans, the employee is considered as the owner of such stocks from the date of the award along with the entitlement to receive dividends and voting rights. However, if the employee fails to fulfil all the conditions provided in the award, then the stocks are forfeited from him. The stocks are not actually transferred to the employee till all the conditions have been fulfilled. These RSA are generally executed through a trust structure. The conditions which are included in RSA plans generally include continuous employment over a period of time and also subject to certain performance parameters (depending on the position and role of employee in the organisation). These plans are formulated on both cash exercise basis and sweat equity basis. In RSAs, the company that is awarding stocks provide usually offer loans either directly or through a trust established by the company in order to purchase such stocks. In RSAs, the employee is treated as a shareholder of the company from the time of the award.  
• Restricted Stock Unit (RSU): RSU is one of the types of ESOPs where the ESOP plan states that an employee is given an entitlement to receive stocks at a future specified date subject to satisfaction of few conditions. Like any other ESOP scheme, this RSU ESOP scheme provides for continued employment of the employment of an employee over a period of time and may also be subjected to few performance parameters. RSU are not similar to RSA ESOP plan. Here in RSU, the employee does not become the shareholder until the stocks are actually issued to the employee and rights related to voting and receiving dividends are also not made available to the employee. However, usually an RSU does provide for dividends in some other form with a view to foster a sense of ownership among the employees. RSU plans are usually executed on both cash exercise basis and on a sweat issue basis. In RSU, the employee becomes a shareholder of the company only on satisfaction of certain conditions and when the date previously decided date arrives.

• Phantom Equity Plan/ Stock Appreciation Rights: An ESOP scheme that is titled as Phantom Equity Plan or Stock Appreciation Rights plan, the employees of the organisation are allotted notional shares or units at a predetermined price. Here, the strike price is not actually paid by the employee but is recorded as the strike price on the day stocks are granted. Once the vesting conditions have been satisfied by the client such as continuous employment period or performance up to certain standards, the employee receives the cash of the net gain, if any, i.e. appreciation on the price of the underlying shares without any cash investment. Some of the plans also offer ‘quasi-dividends’ during the period of the plan. These type of plans offers to foster shared sense of purpose among the employees without changing the share capital structure of the company. This plan does not let the employees become shareholders of the company at any point of time. However, such plans require outflow of capital from the company in terms of the plan.       

Conclusion

From the above discussion it can be concluded that ESOP schemes are indeed a great means of retaining, incentivising and keeping the employees motivated. But before offering such scheme to the employees, it is imperative on part of the company’s management to weigh the pros and cons of having such scheme for the company. Some of the plans require direct participation of the employees in equity of the employees without requiring an outlay of cash whereas other schemes require liquidity in the form of direct cash outflow from the company with no participation in equity to the employees. Therefore, interests of all the concerned stakeholders should be weighed in against all the types of ESOPs before deciding which of the schemes is best suited according to the needs of the organisation.  

Read Our Article:Procedure to Issue Shares through ESOP (Employees Stock Option Plan)