ESOP or RSU: Which is better?
Employee Stock Option Plan (ESOP)
An Employee Stock Option Plan (ESOP) is an employment benefit that gives workers the opportunity to own a part of the company they work for. ESOP holders are issued stock options. This means that they have the option to buy shares of the company at a future date for a predetermined price (known as the exercise price).
For more on ESOP, check out our simple guide here: A 5-minute guide to ESOP and why they matter.
Restricted Stock Units (RSU)
RSU are company shares granted directly to employees with restrictions. RSU plans will typically have vesting periods as well, granting shares to employees over a period of time or when certain milestones are met. RSU plans do not have an exercise price since the employees are granted shares directly.
So, which is better?
Ultimately, both plans are similar in the sense of providing financial benefit for employees. However, there are more benefits for ESOP compared with RSU, so here’s why you should choose ESOP instead.
At first glance, RSU might seem like a more attractive option, with immediate monetary returns. However, RSU can cause some administrative issues due to the direct granting of shares to employees. As such, the shareholder voting agreements can become complicated and messy. In addition, the process of reclaiming unvested shares can be quite challenging.
For example, when an employee leaves the company, taking back the unvested shares will require the employee to sign an agreement to approve the transfer of unvested shares back to the company. If employers are faced with a bad employee departure, it could lead to the unprecedented state of limbo with the shares.
On the other hand, this is avoidable with ESOP, as shares are only granted when the employee decides to exercise them. Furthermore, ESOP can lead to bigger financial gains for employees if the value of the company stock rises. During a liquidity event like fundraising or an exit, employees may also be given the opportunity to cash out their shares by selling them. ESOP is also commonly presented with standardised terms and conditions, thus reducing administrative and legal issues.
Benefits of ESOP include
- All employees have a stake in the business, which will align their interests with the growth of the company.
- Incentive plans are included in ESOP design, motivating employees to improve their performance.
- ESOP ensures the cultivation and maintenance of company culture and legacy
Gains from RSU and ESOP are all considered as part of the employee’s income, and are subject to prevailing income tax rates. The difference thus lies in when the employee is taxed. In short,
- RSU: tax upon receiving shares
- ESOP: tax upon exercising the options, not when receiving the options
In summary, we recommend ESOP as it is simple to execute, reducing the administrative burden for the company as well as ensuring a lower tax burden on employees.
If you would like to find out how you can set up and structure an employee stock option plan for your business, contact us at email@example.com!