Being an employee you receive numerous compensation and perks. Apart from the salary you get holidays and tours. And if your company is publicly listed, then you may get some company shares too! Really? Yes, it is true. In the ever-evolving landscape of employee compensation and incentives, two popular options vie for attention- RSU vs ESOP.
Restricted Stock Units (RSUs) grant employees shares that bloom with time, encouraging loyalty. In contrast, Employee Stock Ownership Plans (ESOPs) endow ownership from the outset, cultivating a sense of partnership.
Here the dilemma arises. Which is better between the two- RSU’s patient growth or ESOP’s immediate connection to acquire the valuable firm equity?
Both mechanisms serve as valuable tools for companies to motivate and retain their workforce while fostering a sense of ownership. However, they differ significantly in their approach and impact on employees’ financial well-being.
In this article, we delve into the comparative analysis of RSU vs ESOP and determine which is better of the two.
RSU (Restricted Stock Units)
It is quite simple to understand. Restricted Stock Units (RSUs) are a form of equity compensation granted by companies to their employees. This means you will get a predetermined number of shares free of cost at the end of the vesting period. The vesting period is a kind of waiting period before which you can’t avail the benefits of the granted stocks.
Let me explain it in simple terms.
See, if you get 300 RSUs (shares) with a three-year vesting period. Then, you will receive those shares only after completing three years of service. The company will grant RSU either in the form of shares or cash equivalent. It will be based on the value of the stock in the future i.e. after the vesting period. Whether you want to receive shares or cash equivalent, it will be entirely your decision.
Unlike traditional stock options, RSUs do not grant immediate ownership of company shares. Instead, they represent a promise to deliver a specific number of shares once a predefined vesting period is complete.
This structure allows companies to retain and incentivize employees, as they must remain with the organization until the RSUs vest. Once vested, employees gain ownership rights to the shares, allowing them to sell, hold, or reinvest based on their financial goals.
Benefits of RSUs
The benefits and description are given in the table below-
|Benefits of RSUs||Description|
|Ownership Stake||RSUs provide a sense of ownership in the company by offering the company’s stock upon vesting.|
|Long-Term Incentive||The vesting periods encourage employees to stay with the company and focus on its long-term success.|
|Reduced Immediate Risk||RSUs shield employees from the volatility of the stock market until the shares are fully vested.|
|Liquidity||Upon vesting, RSUs become liquid assets, enabling employees to sell the shares and access their value.|
|Flexibility||Once RSUs vest, employees can choose to sell the shares immediately or hold onto them. Thus, it offers flexibility in managing their financial portfolio.|
|Potential for Growth||If the company’s stock price increases, the value of RSUs also grows, offering potential financial gains.|
|Tax Benefits||RSUs can have favorable tax treatment compared to other forms of compensation, depending on the country’s tax regulations.|
|Retirement Planning||It can be a valuable addition to an employee’s retirement savings, especially if they vest over time.|
Drawbacks of RSUs
|Drawbacks of RSUs||Description|
|Time-based restrictions & Job dependence||You can avail of the benefits of RSUs only after completing a specific period of employment. If you resign during a vesting period, you will lose RSUs.|
|Performance-based restrictions||You need to achieve a milestone in terms of performance to exercise the ownership of the shares.|
|No immediate liquidity||You can’t sell the RSUs without completing the vesting period. Therefore, it lacks immediate liquidity.|
|No dividend payments||Unlike regular stocks, RSUs usually do not entitle you to receive dividends until the units vest and are converted to shares.|
|Tax Implications||RSUs are subject to taxation upon vesting, which could lead to higher tax bills depending on the stock’s performance.|
|Future Market risk||The value of RSUs can fluctuate with the stock market, potentially resulting in significant gains or losses.|
It’s essential to carefully assess your financial goals and risk tolerance before accepting RSUs as part of your compensation package. Diversifying your investments and seeking professional advice can help mitigate some of these drawbacks.
ESOPs (Employee Stock Ownership Plans)
It is the company’s common strategy to reward its employees. Here, you can buy the company’s shares in the future at a predetermined rate. But it is optional. You can buy the stock and then sell it or retain it later.
For instance, you get 1000 ESOPs on 4th August 2023 with a three-year vesting period of Rs.500. You will get the option to exercise the stock option on 4th August 2026. If the market price is greater than Rs.500 in the year 2026, you will make substantial profits. How? Because you will be able to buy the stock at a comparatively lower rate i.e. at a predetermined price. But if 2023’s market price is lower than the predetermined rate (Rs.500). Won’t it cause losses? Yes, it will. Therefore, in such cases, you can choose to wait until the price of those shares increases above Rs.500.
Here also, the vesting period plays a crucial role in retaining the employees. Once your company grants ESOP, you won’t get them instantly. First, they’ll go to a trust and stay there during the vesting period. After the completion of the vesting period, you will be awarded ESOPs.
Benefits of ESOPs
|Benefits of ESOPs||Description|
|Immediate Ownership||ESOPs grant employees partial ownership of the company from the moment they participate.|
|Potential Tax Benefits||Depending on the country’s regulations, ESOPs may offer tax benefits such as tax-deferred growth. It allows employees to accumulate wealth while deferring tax liabilities until they sell the shares.|
|Company Loyalty and Retention||Employees may be less likely to leave a company where they have an ownership stake.|
|Aligned Interests||ESOPs align the interests of employees and shareholders, as both benefit from the company’s success.|
|Retirement Savings||It serves as a retirement savings plan for employees, providing a financial cushion when they retire or leave the company.|
|Wealth Building||ESOPs offer employees the opportunity to accumulate wealth over time through the appreciation of the company’s stock.|
Drawbacks of ESOPs
|Drawbacks of ESOPs||Description|
|Lack of Diversification||ESOPs tie up a significant portion of an employee’s retirement savings in their employer’s stock. This lack of diversification can lead to increased risk if the company faces financial difficulties or a decline in stock value.|
|Tax Implications||These shares are subject to complex tax rules, and employees may face tax liabilities upon retirement or leaving the company.|
|Limited Influence||Employees may have limited control or voting rights in the company. Even though they hold ESOP shares, which can be frustrating for some.|
|Dependency on Company’s Performance||The success of ESOPs relies heavily on the company’s financial performance, and poor performance could adversely affect employees’ retirement savings.|
|Valuation Risks||Determining the true value of privately held company stock can be challenging. ESOP participants may not have an accurate understanding of the actual worth of their shares.|
It’s crucial for employees to thoroughly understand the details of their ESOP plan, assess their risk tolerance, and consider seeking professional financial advice to make informed decisions about their retirement savings and investment strategies.
RSU vs ESOP: Comparative Analysis
Now, it is time to compare both the stock incentives given by the companies. We will compare them based on different aspects.
1. RSU vs ESOP: Comparison based on basic principles
|Definition||RSUs are a form of equity compensation where an employee is granted a specific number of shares. But they don’t own the shares until the vesting period is complete.||ESOPs are retirement plans that allow employees to become partial owners of the company by acquiring shares at a predetermined rate.|
|Ownership||Employees do not own the RSU shares until they vest. Once vested, they become full-fledged company shares.||Employees are partial owners of the company from the moment they participate in the ESOP. The shares may have a vesting period, but employees have some level of ownership right from the start.|
|Vesting Period||RSUs typically have a vesting period, during which employees need to remain with the company to receive ownership of the shares.||ESOPs may also have a vesting period, but employees still have some level of ownership even during this period.|
|Taxation||RSUs are taxed as ordinary income at the time of vesting, based on the market value of the shares.||ESOPs may offer tax benefits, such as tax-deferred growth, depending on the country and specific plan regulations.|
|Risk||RSUs have less risk for employees as they don’t own the shares until they vest. If the company’s stock price drops during the vesting period, the impact on the employee is minimized.||ESOPs carry some risk for employees since they own the shares immediately, and any fluctuations in the company’s stock price can directly affect the value of their holdings.|
|Liquidity||RSUs become liquid once they vest, and employees can sell the shares at their discretion.||ESOPs may have restrictions on selling the shares, and employees might need to wait for a certain period before selling.|
|Employee Involvement||RSUs are mainly granted at the company’s discretion and are often used as an incentive to retain and motivate employees.||ESOPs generally involve employees making contributions to acquire the shares, fostering a sense of ownership and alignment with the company’s success.|
|Impact on Company’s Equity||RSUs dilute the existing shareholders’ ownership when the RSUs vest and become shares.||ESOPs dilute the existing shareholders’ ownership when new shares are issued to employees as part of the plan.|
Many folks have the following queries-
“Is RSU part of CTC?”
“Is ESOP part of CTC?”
Yes, both of them are a part of the CTC package. But most of the employees find it difficult to understand their benefits. Both of them are taxable income!
2. RSU vs ESOP: Key Differences
|Grant Date||Issued after the issuance||Issued any time after the issuance|
|Exercise Price||None||Pre-determined price|
|Action||No need to do anything. |
Because shares are deposited into the brokerage account.
|Employees need to take action to utilize their options|
|Voting rights||None||Only after purchasing the shares|
|Shareholders rights||Restricted||Full rights after purchasing the shares|
|Mode of settlement||Stock or Cash||Stock|
(Employees get the share at fair market value)
(Stock price may be equal or less than the predetermined price)
RSU vs ESOP: Which is Better?
Here comes the part of the judgment in the battle of RSU vs ESOP.
The choice between RSUs (Restricted Stock Units) and ESOPs (Employee Stock Ownership Plans) depends on various factors, including your financial goals, risk tolerance, and the specific terms of each plan.
Surprisingly, there is no definitive answer as to which is better, as both options have their advantages and disadvantages.
You can consider some of the following points to make an informed decision.
RSUs can be better if you prefer-
- Lower immediate risk since you don’t own the shares until they vest, mitigating the impact of stock price fluctuations during the vesting period.
- Value flexibility, as RSUs become liquid once vested, allowing you to sell the shares immediately or hold them for potential future growth.
- Incentive-based compensation structures, because RSUs are often used by companies to retain and motivate employees.
ESOPs might be better if you prefer-
- To have ownership in the company right from the start, fostering a deeper sense of alignment with the company’s success.
- Comfort with the potential risks associated with owning company shares, including potential fluctuations in stock value.
- Potential tax benefits, as some ESOPs may offer tax-deferred growth opportunities depending on the country’s regulations.
We hope the above sections will help you to make a wise decision in the battle of RSU vs ESOP. Ultimately, the best choice depends on your personal financial situation, long-term goals, and your belief in the company’s future prospects. We recommend you consult with a financial advisor who can assess your specific circumstances. Thus, it will help you to decide which incentive aligns with your overall financial plan.