Equity Based Compensation allows Employees to share value creation and ownership of the business. This type of incentives may take many form ESOPs, RSU, SARs, Phantoms and ESPS.
Companies offer equity compensation or stock options to key employees as it creates a sense of ownership in the company and in that sense links the financial reward from their stock holding with the performance of the company. It helps in getting and retaining employees that are an asset to the company.
It thus works as a –
- Motivational tool
- Compensatory tool
- Performance tool
- Talent hunting tool
- Wealth generating tool
- Matching tool
ESOP is anacronym for Employee Stock Option Plan which as the name suggests is the right (not an obligation) given to an employee to buy shares of the company at a price fixed on the date of grant. It is also called an equity compensation plan. It makes the employee shareholder or owner in the company to the extent of the options held by them.
Absolutely not. Equity based compensations (EC) are many, and it’s up to the company to choose the right instruments that are the best in view of its strategic goals, objectives and constraints.
Equity Compensation is an incentivization tool. It may be implemented by listed as well as unlisted companies. In fact, more and more unlisted firms are demanding Equity Compensation Plans because they can then attract and retain better talent.
It is best for your company you are expecting to grow. Growth can be in the form of:
- Prior to executing expansion plans
- Prior to Funding from VC/PEs etc
- Prior to listing of shares
- Expected increase in stock prices (increase market share, favorable market conditions etc)
Employees that prefer to choose an Equity based Compensation are far more likely to have a greater sense of ownership. They enjoy the benefits of owning shares of the company in the form of dividends or market price appreciation, thus augmenting their wealth.
Every country has its own regulatory body and framework to guide equity compensation Plans.
- SEBI (Share Based Employee Benefits) Regulations, 2014
- Companies Act 2013
- Companies (Share Capital and Debentures) Rules , 2014
- Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017
- SEBI (Prohibition of Insider Trading) Regulations, 2015
- SEBI (Listing Requirement and Disclosure Requirements) Regulations, 2015
- SEBI ICDR Regulations
- The company gains employees’ goodwill, loyalty and commitment.
- Employees are motivated and encouraged to think like owners.
- Helps attract fresh talent on a regular basis
- Reduces attrition rate
- Can be used to finance growth through its tax-privileged status in a cost-effective manner.
- An Equity based Compensation can create cash-flow issues for a company. If a company borrows money to fund an Equity based Compensation, it will have to allocate significant future earnings towards repayment.
- Dilutes ownership
- Other hygiene factors are not in place – communication, transparency, objectivity
- Design flaws – vesting conditions, exercise process
Misconception: Very often, people fear that by establishing an Equity based Compensation, they will lose control over their company. It is not so. On the contrary, Equity based Compensation motivate employees to think like the owner of the company, wherein the control remains with the actual owners.