Employee Stock Option Plans or ESOPs as they’re more commonly known, are employee
benefit plans which offer employees a stake in the entity. These plans are just options that could be purchased by the employees at a specified price before a deadline. There are defined rules and regulations laid out in the law that employers need to follow for the granting of ESOPs to their employees.
For the longest time, ESOPs were considered the best retention strategy out there to retain the employees and incentivize them to work harder. It’s a win-win situation for the company and the employees – the company can retain its top employees and the employees can cash out big when the company goes public.
Of late, a lot of startups are also on an ESOP buy-back spree. Typically, ESOPs get liquidated at the time of IPO or an acquisition. But not all companies have a roadmap to IPO/ plans to get acquired. In this case, the employees won’t be able to appreciate the value of the ESOP or liquidate the stock options. Another huge disadvantage of ESOPs is that they are taxed twice in the hands of the employees – one as a perquisite and one as capital gains at the time of sale.
Companies have also experimented with other ways to give employees the incentive derived from ESOPs. Stock Appreciation Rights (SARs) are one of them.
A stock appreciation right entitles the holder to receive the benefit of the increase in value of a company’s stock in cash or stock or a combination of both.
As per Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014, SAR is defined as, “a right given to a SAR grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company”.
For example, if 100 SARs are issued to an employee when the stock price of the company is at $10 and in a few years, the stock prices rise to $25, then the employee shall be entitled to receive $1500 ($15 x 100 SARs) in cash.
SARs have some advantages over ESOP:
- Dilution of shareholding can be reduced/ eliminated;
- From a financial disclosure and compliance perspective, SARs are not governed by
Companies Act and do not require much disclosure - For an employee, they don’t have to pay exercise price and there is no double taxation
(like in the case of ESOPs). SARs get taxed as a perquisite at the slab rates in which the
employee falls.
At the end of the day, issuing ESOPs or SARs is a choice that the founders and investors have to make, depending on the company’s roadmap for the future.
