DIFFERENT FORMS OF EMPLOYEE STOCK BENEFIT SCHEMES

What are Employee Stock Options?

Employee Stock Options are defined as “the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price”;

The above definition is given under the Section 2(37) of the Companies Act, 2013 but what significance do the Employee Stock options hold for a Corporate and its Management!

There are various aspects to Employee Stock Options such as its benefits to the Management, Legal Compliances, Tax Implications, Accounting and above all the various types of Options or say tools available with the Management to fit their purpose and goals.

As Employee Stock Options is itself a type of tools to incentivize the Employees, so the terminology that would best fit as the Theme of this article would be Employee Stock Incentive Schemes or Employee Retention Tools. I will keep the term short to “Stock Options”.

In this article, I will not touch upon the legal or taxation side of Stock Options and would rather be focusing on the types of Stock options and their respective benefits.

Over the years, Stock options have assumed significant importance in the corporate scenario, more particularly by the Startups who often utilize it as a mode to lure highly skilled and efficient personnel’s. The benefit of offering stock options not only remains to recruiting a talent but also these options act as additional monetary instruments and are often clubbed with the monetary payout forming part of Annual Package offered.

The underlying reason for offering Stock options as an element of the annual Package goes beyond the usual perception that the Startup/Company saves upon its liquid cash flows. Though saving upon the cash flows holds its share, but here the company is playing on the psychological grounds. By offering Stock options, the prospective employee is made to think that he already owns a part in the company or he will own a part once he becomes a working member of the entity. To add to it corporate ensures the longetivity of employee’s service.

The benefits are not limited to the one’s stated above and same will be detailed out later in the article but first we learn about various stock option schemes that can be created in an Entity to suite its requirements.

Let us start with learning the common terms which is indifferently used in every type of Stock Option;

1. Exercise: intention by an Employee to the Company to purchase the Shares underlying the Options vested in him.

• Exercise Price: price payable by an Option Grantee in order to exercise the Options.

• Spread: Thedifference between the exercise price and the fair value of the Stock at the time of exercise of options.
• Vesting Condition/period/date: A requirement prescribed by the company before the option can be availed. Usually the requirement put forth pertain to Continuation with company or meeting budgeted goals.

TYPES OF STOCK OPTIONS

EMPLOYEE STOCK OPTION PLAN

Employee Stock option plan (ESOP) or Employee Stock option scheme (ESOS) is the most popular and commonly used tool among the corporate for incentivizing their employees with Company’s stock. ESOP’s are Options with the Stock/share of the Company as the underlying asset having a definite vesting period and an exercise Price. These options are converted into Equity shares once the employee exercises options. These options have a predetermined Exercise price which is usually discounted to the Fair value of options.

When the options are exercised, if the fair value of shares at that time is higher than the exercise price, the employee gains the spread and tax is leviable on the spread as Perquisites Tax.

 STOCK OPTIONS CYCLE

Important Points to note:

1. Grant of options does not give any voting rights to dividend rights to the Employee. Options are mere exercisable rights in nature and do not in any way be taken as holding of shares of the company. It is only when shares are issued upon exercise of options; the employee enjoys the rights attached to shares.

• Options are non-transferable rights meaning that the same can’t be traded for cash or any other thing. The employee to whom options are granted has the exclusive right to exercise them.

• ESO can only be issued to whole-time employees of the Company, its holding or associate company but cannot be issued to*:-

1. Promoter or any employee belonging to the Promoter Group.
2. Director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company

*DIPP Registered Startups are exempted from this condition

STOCK APPRECIATION RIGHTS

Stock Appreciation Rights (SAR’s) is a stock option with two comes with two sides. Though, technically SAR’s cannot be called as a wholly a stock option scheme, as SAR’s provide a right to cash bonus equal to the surge in the price of options over the time granted to an employee.

Likewise ESOP, options with company’s Stock as an underlying asset are granted to employees having a stated vesting period. When these options are exercised, the employee becomes eligible for cash amount equal to the difference between the fair price of options at time of exercise and the exercise price. This surge in the value of Stock is paid in cash to the employee. Therefore, the USP of SAR is that they provide the benefit of upside in stock to the employee without exposing them to the downside; meaning that if the value of equity tanks below the exercise price, employee is not forced to pay any amount to company.

Now, why I said that SAR has two sides, because the upside difference in the value of stock can also be paid by allotment to such no. of shares, whose value is equal to the surge in the value of the consolidated options.

So, the Company has two options to choose from, either to pay in cash or issue equity shares. Now the USP of SAR for the company is that it offers discretionary power to the Management to choose the better option depending upon the cash flow situation of the Company and the willingness of the existing shareholders to dilute their Equity. If the Company has surplus cash flows, it can disburse cash Bonuses to SAR Holders and on the other hand where the company is facing cash crunch but the promoters are not hesitant to dilute Equity, company can go for Equity shares allotment.

                             

Key Features of STOCK APPRECIATION RIGHTS

1. Understanding SAR is not tough task but these have been quite famous among the Corporate in present times. The flexibility offered makes them quite favorite of the Management.

• SAR do not guarantee any fixed no. Shares that will be allotted to any grantee. This feature makes a SAR scheme completely different from other Stock option tools as other schemes have a fixed no. of shares to be allotted to an individual grantee.

• Besides in a SAR, Employee are not required to pay any exercise price so the Exercise price represents just a Notional Number to calculate the upside in value of stock of Company.

PHANTOM STOCK

Phantom Stock is a sibling tool to SAR’s. The only difference from SAR’s lies in the fact that the cash bonus is calculated on the basis of the full value of fixed number of Stock aka options granted to an employee after a predetermined period. Therefore, a Phantom Stock Scheme makes an employee eligible for cash bonus equivalent to the value of fixed number of Options.

Also, Phantom Stock may not be exercisable at the option of the Employee. These usually have a predetermined period upon which these automatically vest and the employee becomes eligible cash bonus. Because of this feature of Phantom Stock are also called Deferred Compensation Plan.

Maturity of Phantom Stock at times is also linked to attainment to certain targets. Like SAR’s, Phantom Stock also offer the flexibility to the Management to structure it according to its requirements. It is upto the Management to keep the Phantoms linked to the Time bound maturity or Performance linked maturity.

Key Features of PHANTOM

1. Unlike SAR’s, Phantoms allow the employees to enjoy the monetary benefit of full value of stock as no exercise price exists under these plans.

1. Phantom stock plans are a good employee motivation tool for employers and a solid cash incentive plan for employees. Even if the Stock goes down over a period of time, neither the employer nor employee loses any money.

RESTRICTED STOCK UNITS

Restricted Stock Units (RSU) obtains their name from the direct restriction or conditions placed on the vesting of options granted under such scheme. Under a RSU Scheme, fixed number of option is granted to an employee and these are subject to vesting upon meeting certain conditions. Now these conditions can be anything.

Continuity of Service to the Company, meeting Performance Targets, Company achieving targeted Valuation are the mostly commonly placed conditions on RSU’s. Upon fulfillment of any or combination of specified conditions, an employee becomes eligible to exercise his options and shares be issued to him. Under RSU scheme, usually companies do not keep any purchase price to be paid by the employees at the time of exercise but a Company always has a right to do so. Therefore the spread can the whole value of share or difference between the FV and EP.

RSU are also called as Performance Linked Stocks as primarily this tool is used for employees working in sales, marketing or product division of a Company.

Salient Features of RESTRICTED STOCK UNITS

1. RSU’s are subject to vesting conditions that are linked to achieving targeted performance or period of Service to the Company.

• Like SAR and Phantoms, RSU’s also are issued without any price to be paid upon exercise.

• Like ESO’s, RSU’s are also issued to whole-time employees only excluding employees which are promoters or holding position of Director which hold 10% or more of voting rights.

EMPLOYEE STOCK PURCHASE PLANS

Employee Stock Purchase Plans (ESPP) allow an employee to purchase Company’s shares, often at a discount from Fair Market Value. Usually, ESPPs are being framed for offering shares as a part of public issues.

So under ESP plan, an employee is offered an opportunity to purchase Shares of the Company at a price less than what public has to pay on those shares. ESPP is meant for Executive level Management employees whose presence holds substantial influence on the performance of the Company. As under an ESPP, Equity dilution in all circumstances takes place, therefore shares under such Plans are meant for Key Employees of the Company.

Now, giving a good reading to the above mentioned tools would enlighten you with the options available with the Management to incentivize their Employees for their hardwork, determination towards reaching the Company’s goal.

Now the Question is which is the best suited plan to be implemented to cater the requirements of an Employer?

The answer is simple. There is no best plan that can suit to any employer in general. Because Stock options are meant for Employees, their needs and means to keep them motivated can be a complex task. From top executive employees to junior level staff, a single tool might fail to create an impression for each and every employee.

Opting for a Stock option tool is not a mere influence of employee but also, what an employer wants from its employees plays a part.

As we have read above, where the criteria for grant comes down to achievement of target sales, RSU can be the best fit but the same will not fit for employees at heading roles because, they are into leadership and management role. Their performance and contribution cannot be tracked in terms of sales. Therefore, an RSU plan will not work for such employees. They can best tempted with a ESOP or a Equity SAR Plan.

So, our learning is, a single policy would not do for a corporate which has to keep all its employees motivated and passionate for their respective jobs. A Company can always have multiple policies/Plans implemented for each category/level of Employees.

*Incentivize, Retention, Motivation and Persuasion

DISCLAIMER: The entire contents of this article have been prepared on the basis of relevant provisions and the information existing at the time of preparation. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, the author assumes no liability therefore. Users of this information are expected to refer the relevant law. The information as given in no case shall be construed as a Professional advice or opinion. IN NO EVENT THE AUTHOR SHALL BE LIABLE FOR ANY DIRECT, INDIRECT, SPECIAL OR INCIDENTAL DAMAGE RESULTING FROM OR ARISING OUT OF OR IN CONNECTION WITH THE USE OF THIS INFORMATION.