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What are the differences between ESOP and RSU?

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What are the differences between ESOP and RSU?

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If you are working as a salaried employee or a director in a company, your company may choose to reward you through various means like Employee Stock Option Plan (ESOPs) or Restricted Stock Units (RSUs). It is important to understand how RSUs vs ESOPs compare, so you can make the most of the shares allotted to you through either of these routes. 

At the most basic level, both RSUs and ESOPs are shares issued to employees as an incentive. But when you dig a little deeper, you’ll see that there are several key areas of difference between ESOPs and RSUs. 

To understand these distinctions better, it is essential to first get a better idea of what ESOPs and RSUs are. So, let’s get started there.

What are ESOPs?

ESOPs or Employee Stock Option Plans are schemes launched by companies, wherein certain select employees are given the option to purchase stocks of the company at lower or discounted prices. The price is predetermined, as is the future date on which the eligible employees can exercise their ESOP.

ESOPs typically come with a vesting period. The future date on which employees can purchase the shares using their ESOPs comes at the end of this vesting period. And it is known as the vesting date. During this vesting period, employees need to continue working at the company and must not terminate their employment. Only then can they exercise their right to purchase the shares via the ESOP scheme. 

The vesting period is generally at least a year long, so the company can ensure that valuable equity is not allotted to short-term employees. On the vesting date, employees can choose to exercise their options and purchase the company’s shares if it is beneficial to them. Typically, if the grant price of the shares is significantly lower than the market price of the shares on the vesting date, it can be profitable to exercise ESOPs.

An example of how ESOPs work

Say you work in a company that has launched an ESOP with the following particulars —

  • Eligible employees receive 100 options on April 1, 2022
  • The ESOPs have a 3-year vesting period
  • The grant price is Rs. 200 per share

Being an eligible employee, you receive your 100 ESOPs. And on April 1, 2025, three years from the ESOP issue date, you can choose to exercise your options. If the market price of the company’s shares is greater than the grant price of Rs. 200, you can use your ESOPs to buy the shares at a lower price. But if the market price of the company’s shares is less than the grant price of Rs. 200, you can wait and exercise your ESOPs at a later date, when the market price increases. 

What are RSUs?

RSUs or Restricted Stock Units are stocks that companies offer their employees as a form of compensation. They may be given as a part of a job offer, or they may be offered to existing employees. The employees who receive RSUs from the employing company need to hold the shares for a certain vesting period. Only after this period can they sell their holdings for a profit if they wish to.

RSUs can be granted in the form of shares or given as cash equivalents. This decision may be left to the employer or the employee, based on the terms and conditions of each RSU issue. Furthermore, such stock units can come with different types of restrictions, as outlined below.

1. Time-oriented restrictions

Some RSUs can only be sold after a specific period, as mentioned above. These are time-based restrictions, and the employee has to remain at the company during the vesting period, so they can unlock the RSUs allotted to them.

2. Milestone-oriented restrictions

Some RSUs come with milestone-based limits, where they can only sell their holdings after they achieved a specific milestone in the company. This encourages employees and acts as an incentive for them to perform better.

3. Time-oriented and milestone-oriented restrictions

As you may have guessed, these restrictions include a specific vesting period as well as a milestone. Only after the employee has achieved the milestone, and only after the said vesting period is complete, can the RSUs be sold.

An example of how RSUs work

Let’s say you work as a sales manager in a company that has issued RSUs with the following particulars —

  • You are eligible for 100 shares of the company
  • The restriction is milestone-based
  • You need to achieve a sales figure of Rs. 1 crore to unlock the restrictions

So, let’s assume that you achieve this sales figure 18 months after you’ve been allotted the RSUs. You can then choose to hold the stocks or sell them, based on the market conditions prevailing at that time.

The key differences between ESOPs and RSUs

Although both these kinds of employee-oriented stock issues have many similarities, there are also several differences between ESOPs and RSUs. Check out how ESOPs vs RSUs compare in the table below.

Particulars

ESOPs

RSUs

Nature of issue

Options are issued.

Stocks are issued.

Pricing

A grant price is fixed when the ESOPs are issued.

No specific price is set for RSUs.

Voting rights for shareholders 

Shares purchased via ESOPs come with voting rights.

RSUs allotted to employees do not carry any voting rights.

Dividends

Shares purchased via ESOPs may offer dividends to shareholders.

RSUs do not give shareholders any dividend benefits.

Option to purchase shares

ESOPs give employees an option to purchase the shares after the vesting period.

RSUs are directly allotted to the employees as shares once the restrictions are met.

Nature of limitations

ESOPs typically come with a vesting period, after which employees can purchase the shares.

The nature of limitations associated with RSUs can be time-based, milestone-based or a combination of the two.

Nature of settlement

Shares of the company

Shares or cash equivalents

Type of companies that issue these shares

High-growth startups and young companies

Older and more established companies

Summing up

This sums up the key differences between ESOPs and RSUs. If your company offers you either of these benefits, it is advisable to make the most of it, since both ESOPs and RSUs can be highly beneficial to the employees who receive them. Do keep in mind though, that both RSUs and ESOPs are taxed under the Income Tax Act, 1961.

In case of listed companies, a short-term capital gains tax (STCG) of 15% is levied on the gains if the holding period is less than one year. In case the stocks are held for more than one year, no tax is due. For the shares of unlisted companies, gains are taxed at the applicable slab rate if the holding period is less than one year, or at 20% with indexation if the holding period is more than one year.

Frequently Asked Questions (FAQs)

1. Why are RSUs taxed so high?

The rate of tax on RSUs is not very high. In case of shares of listed companies, the tax rate is just 15% if the holding period is less than a year. But if the holding period is more than a year, your gains are tax-free. 

If the RSUs are from an unlisted company, they are taxed at your slab rate (for holding periods of less than a year) or at 20% with indexation benefits (for holding periods of more than a year).

2. Are RSUs worth it?

Restricted Stock Units (RSUs) help boost employee morale and act as an incentive for employees to perform better. And they help employees partake in the results of their hard work by giving them shares of the company, so they can benefit from the stock appreciation and the growth of the company. So, for established companies that have a strong market presence, they are definitely worth it.

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