In this blog post we will compare some of the most used ESOP compensation structures and how they differ from each other.
First, we will start with a short description of these three types we will compare in this post:
- Restricted Stock Awards (RSA): An immediate stock grant, where the shares are restricted and the receiver has to earn the right to keep them, by meeting certain vesting conditions.
- Restricted Stock Units (RSU): Is a promise to receive free stocks in the future after meeting certain vesting conditions.
- Stock Options: A stock option is a right (and no obligation) to purchase a set number of shares in the company in the future for a pre-determined price.
Now let’s explore point by point the differences between these three structures:
- Restricted Stock Awards: The receiver owns actual shares and is hence a shareholder from the time of grant
- Restricted Stock Units: The receiver does not own actual shares and is not a shareholder until the vesting conditions are met and the RSU is settled into shares.
- Stock Options: The receiver does not own shares and is not a shareholder until the vesting conditions are met and option holder choose to exercise the option into shares.
- Restricted Stock Awards: The RSA holder have voting rights from grant date (given that the shares owned have voting rights)
- Restricted Stock Units: No voting right (until settling into shares)
- Stock Options: No voting right (until exercising)
- Restricted Stock Awards: The RSA holder are entitled to dividends
- Restricted Stock Units: No dividends
- Stock Options: No dividends
- Restricted Stock Awards: There is usually a purchase cost of the RSA. However, the company can choose to either offer the RSA for free or at a discounted price.
- Restricted Stock Units: No cost to receive RSU´s and no cost of settling the RSU´s into shares
- Stock Options: There are typically no cost of receiving the stock option. There is a cost of exercising the stock option into shares after the vesting conditions are met. This is called the strike price or exercise price and is set by the company at the time of issuing the stock option. The price is normally set to the fair market price of the shares of the time of the stock option grant.
The tax regime is dependant on the jurisdiction. However, it is in many cases very similar(as described below). Although if your company is paying tax to another company then Norway, we advice you to check this further. The rule of thumb for taxation in Norway is that if the employee receive any benefit, the employee should be taxed with income tax and the company needs to pay employer´s tax (Arbeidsgiveravgift / AGA).
- Restricted Stock Awards:
- If the employee pays the fair market price for the shares, there are no immediate tax requirements. Any subsequent gains/loss are taxable according to the capital gain tax
- If the employer are given the shares or get to buy these at a discount, then the difference between the fair market value and paid cost is considered a benefit which is taxable as income tax. Any additional gain/loss after this are taxable according to the capital gain tax
- Restricted Stock Units:
- No tax is triggered upon the time of grant. First when the RSU is settled into shares, a tax requirement is triggered. This tax is calculated as income tax based on the total value of the shares received.
- Stock Options:
- No tax is triggered upon the time of grant. First when the Stock Option is exercised into shares, a tax requirement is triggered. The employee has to pay income tax which is calculated by: Fair market price upon time of exercising - Total exercise cost - Stock Option purchase cost (last is usually zero). Any subsequent gains/loss are taxable according to the capital gain tax
- If the company, stock option and the option receiver qualifies according to the “Stock Options for Startups scheme” introduced in 01.01.2022 (see this blog post), the tax requirement is more advantageous: No tax are payable until after the shares have been sold and all tax is calculated based on capital gain tax. This applies to both the employee and the company.
- Restricted Stock Awards: Since the shares are bought or owned, there is a risk of loss if the share price decreases.
- Restricted Stock Units: There is no risk involved prior to settling the RSU´s. At that point, the shares are given free of charge. From there, the receiver is exposed with the tax amount which can be greater than the return if the value of the shares decrease below this.
- Stock Options: This is considered risk free until exercising. After that point, the receiver is exposed with the exercise cost which can be greater than the return if the value of the shares decrease below this. In public companies, this is not a problem. But it might be more challenging for private companies where the stock is not as liquid.
💡 It is normal that ESOP plans comes with certain conditions. Most normal and central to ESOP structures, is the vesting conditions the receiver has to fulfil for the receiver to earn the right to the shares. This often works the same for all the covered ESOP types. We will cover more of these in a separate blog post as we are highlighting the differences for now. Stock options agreements typically include the following which is not part of the other structures:
- Exercise price: The price to pay per share when exercising the stock option
- Expiration period: When the stock option expires
- Post termination exercise clause: How long the employee has to decide if he/she wants to exercise the vested stock options after the employment is terminated. There may be different reasons to why an employee leaves the company. Different reasons may lead to different post termination exercise intervals.
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