Equity Based Compensation allows employees to share value creation and ownership of the business. This type of incentives may take many forms such as: ESOPs, RSU, SARs, Phantoms and ESPS.
Companies offer equity based compensation or stock options to their key employees as it creates a sense of ownership of the company in the minds of the employees 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 an acronym 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 a 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 is up to the company to choose the right instruments that are the best in view of its strategic goals, objectives and constraints.
Restricted Stock Units (RSU) are typically stock options granted at a deep discount to fair market price or at face value to the employee.
Stock Appreciation Rights (SARs) entitle the holder to benefit from the increase in value of the underlying equity price over a given time period. Here the participant receives the appreciation in value which the Company settles in Equity.
Phantom are pseudo ESOPs, it entitles the holder to benefit from the increase in the value of the underlying equity price or any other selected parameters over a given time period, here the participant receives the appreciation in value which the Company settles in cash.
Employee Share Purchase Scheme (ESPS) are broad based ownership plans which allows equity participation to employees at all levels, here the employee are given option to participate and make time based contributions typically from there payroll which may also be matched by employer contribution and the fund thus collected is utilized in buying equity of the company and shared with the employees in regard to their contribution to the plan.
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 when 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.