Satisfied employees are the driving force for any company’s operations. For a similar reason, companies usually incentivise their employees in various ways over the regular compensation. The perks can be in any form, such as recreation leaves, medical insurance, gifts, bonuses, part in the equity, etc.
The equity offered to employees can be the restricted stock units (RSU) or the employee stock option plan (ESOP). Usually, both these terms may seem to be similar in function of offering equity to the employees. However, there is some close difference between RSU and ESOP. Read further to understand this distinction.
What is ESOP?
Companies offer a right to buy their equity shares at a future date to employees. This incentive is known as the Employee Stock Option Plan (ESOP). In this scheme, the employees are eligible to purchase equity shares of their company in future after a certain vesting period. The vesting period is the minimum duration an employee is expected to work with the company before being eligible to exercise the ESOP. Taxation benefit is offered by the ESOPs in terms of deferring the tax till retirement with other tax benefits.
Let us understand ESOP with an example:
A company offered its employees 100 ESOPs at a price of ₹250 each, with a vesting period of three years on July 1, 2024. So, after July 1, 2027, that employee is eligible to purchase the equity shares of that company. If the market price of shares after this vesting period is more than ₹250, then it is profitable for the employees to buy them. In the other case, if it is less than or equal to ₹250, employees can choose not to exercise this option.
Read more about the ESOPs: ESOPs: Empowering employees with ownership.
What is RSU?
The Restricted Stock Units (RSU) are the shares offered by the company to its employees with restrictive conditions of the vesting period. In this scheme, the company pledges some shares to employees (employees do not pay for it), and after the vesting period, the employee gets the ownership of these shares. This vesting period is restricted in several ways:
- The time restriction – the employee has to work with a company for some specific number of years to avail the ownership of shares.
- The milestone restrictions -A company prescribes a specific event to avail the ownership of the stocks. This event can be the revenue exceeding a notable mark, certain minimum profit limits, specific customer engagement data, etc. Such restrictions can motivate employees to work harder for the company.
- Instalment – A specific % of stocks are pre-decided by the company and can be availed after a decided time. Adding such various instalments, the company offers stock to its employees.
Let us understand RSU with an example:
A company pledges 100 shares with a milestone (event) restriction of the vesting period. The milestone will be achieved when the company earns revenue of more than ₹10 crore. So, when a company reaches this prescribed milestone, the employees become eligible to avail those 100 shares. Further, as per market conditions, employees can decide whether to hold or sell them.
The difference between ESOP and RSU
These equity offering incentives of ESOP and RSU are sometimes used synonymously. However, there are vast points of distinction between them.
| Point of difference | Employee Stock Option Plan (ESOP) | Restricted Stock Units (RSU) |
| Purchase of shares. | Employees can purchase shares at a decided price after a certain period. | Employees do not pay to buy the shares. These shares are pledged by the company. |
| Risk | High risk, as it depends on market conditions, whether the stocks are favourable or not. | Comparatively less risky as the employees receive shares irrespective of market conditions. |
| Vesting Period | A specific duration of the vesting period is pre-decided. Employees can avail of these shares after the duration. | The vesting period varies according to the period, milestone conditions or the instalment. |
| Price | The price of shares for purchase in future is decided while issuing the ESOP. | None |
| Process | It is at the employee’s discretion whether to exercise the option after the vesting period. | Shares are owned by the employee after restrictive conditions of the vesting period are met. |
| Shareholder rights | After exercising the option, the employee has all shareholding rights, such as voting, dividends, etc. | Restricted rights of shareholding in terms of dividends, voting rights, etc. |
| Settlement | The settlement is done in shares. | The settlement is done in shares or cash. |
| Type of Companies | Usually, ESOPs are offered by startups and new budding companies. | The RSUs are usually offered by established and mature companies. |
| Taxation | After the vesting period, if ESOPs are sold, then their profit is taxed as short-term capital gains.It differs as per the listing status and period of holding after vesting. | The RSUs are taxed during vesting as other equity shares. If the settlement is done in cash, the benefit is taxed as per the income tax slab. So, it differs as per the listing status and period of holding after vesting. |
Also, read about: Beyond the paycheck: Exploring compensation meaning through equity
Bottomline
The question remains: Which is better, RSU or ESOP?
These incentives by the companies serve different purposes. If an employee is willing to obtain shareholder status and benefits, ESOPs are the most suitable choice. However, if an employee wants to profit with less risk, then RSUs are a great choice.
Both options have their own set of limitations. The ESOPs are risky enough as market conditions are uncertain, and without a profitable situation in the market, paying a pre-determined price is risky. However, the RSU does not offer any tax benefits and shareholding status. Thus, as per the objectives of an employee regarding the company, investment and overall market status, the decision can be taken.
Read more about employee compensation: Stock compensation: Everything you need to know.
FAQ
Q1. Is it better to take RSU of stock options?
The Reserved Stock Units (RSU) have the profit benefit if the market is in good condition for the company’s stock. These are pledged by the company to the employee, so no price is paid. However, they have some restricting conditions regarding the event or time after which an employee can exercise his power to sell/hold as a shareholder. So, if the conditions are feasible for the individual, it is a good option to take RSU.
Q2. What is the difference between ESOPs and RSU?
The main difference between the Employee Stock Option Plan (ESOP) and Restricted Stock Unit (RSU) is regarding the purchase of shares, vesting period and the shareholding rights. ESOPs offer options to employees to purchase shares at a pre-determined price after the vesting period, which is usually some years of service after the issue. However, RSUs are the purchased stock units given to employees as stocks or cash after the vesting period, which would be restricted to certain events or times. Also, the ESOP gives full shareholding powers after the employee exercises the option, while RSU never grants this power.
Q3. What is better, RSU or ESOP?
Deciding upon the better option between RSU and ESOP should be backed by several factors, such as employee’s objectives regarding the company, market conditions, and investment, and the company policies regarding ESOP or RSU. The RSU offers profitable investments with restrictive conditions and no shareholding rights. ESOP offers shareholding rights with an option to exercise the option as per the market conditions.
Q4. What are the benefits of RSU?
There are several benefits of Restricted Stock Units (RSU), like the shares offered to employees without them paying for it. The company pledges those shares to the employee. Moreover, some companies may provide an option of settlement in the form of shares or cash. The matured companies offering RSU have great potential in feasible market conditions.
Q5. Can RSU increase in value?
The payoffs of RSU depend on market conditions. We can understand it with the help of an example: A company offers 100 RSU of ₹60 to employees (value of ₹6000) for a milestone restriction of ₹10 crore revenue for the vesting period. So, when the company achieves that milestone there is the possibility of positive market sentiments, which would eventually increase the stock price to ₹120 (value of ₹12000). Hence, the RSUs can increase in value according to the market conditions.
