Unravelling the Mysteries of RSU, ESPP and ESOP

A good remuneration package would definitely enthuse and excite young professionals while stepping into the world of employment. Many of them would have been recruited from the campus while others might have come through the process of examination and interviews. Most would perhaps only be aware of the quantum of compensation that they are going to receive.

It is often that employers show high CTC to prospective employees and use terms like RSU, ESPP and ESOP, to describe the components of the package. Employees may or may not know about these terms and  their tax implications. Half-knowledge can leave them perplexed when they grapple with these jargons and try to come to terms with them.

So what exactly is RSU, ESPP, and ESOP? Well, by the time this article is completed the reader will have a fair comprehension about these seemingly difficult abbreviations. Let us take them one by one:

1. RSU stands for Restricted Stock Units. The connotation of the term when explained is not very difficult to understand. When an employer offers RSU to its recruits, it is in effect offering Stocks to them without any strings attached except for the fact that the Stocks have a vesting period. Vesting period is basically the term period for which the employee has to wait before he becomes eligible to own it. A 500 RSU with 3 year vesting period means that the employee can claim the 500 shares after he has successfully continued in his job for a minimum of 3 years. Once the employee owns the stock he or she is at liberty to hold it or sell it off. Organizations often use RSU as an option for paying incentives and rewards to its employees.

E.g. A total of say 5 million RSUs' may be offered to 5000 employees of an organization. Wipro has done so in the past giving away 4.5 million shares to its top managers totaling 1200 heads.

From the organization's point of view, RSU can be a useful tool to fight attrition and enhance loyalty. If the organization is reputed and its stocks are considered blue-chip in the market, the employee will think twice before switching jobs. Variants of the offer or the manner in which RSU is offered can differ from company to company. A 25% RSU each year will mean that 25% of the total stock quantity will vest with the employee each year, but he will be able to utilize them only after 4 years when he owns 100% of the stocks.

Many companies expect that their employees will sell off their RSU within a specified time if they choose to part ways.

2. ESOP means Employee Stock Options. As the term signifies, ESOP is about 'options'. Many companies in India offer ESOPs to their employees. This basically means that the employee has the option to purchase stock of the company at a future date at a pre-determined price. If the market price of the stock is above the procurement price, the employee stands to gain by selling it off immediately. If however the price is below the agreed price level, the employee has the option to set aside his option and not exercise it.

A simple example can be used to illustrate the point. A particular employee is offered 1000 ESOPs' by his employer with a vesting period of 3 years from 1st September 2013. The price agreed upon is Rs. 100 per stock. On 1st September 2016 the employee is entitled to exercise his option and purchase 1000 of the company's stock at the pre-determined price of Rs. 100.

If the market price of the stock on 1st September 2016 is Rs. 150, the employee can immediately sell-off his stock holding and make a profit, while if the price of the stock is Rs. 80, he may not exercise his option of making the purchase at the pre-determined price.

3. ESPP is 'Employee Share Purchase Plan'. Under such a plan the employee has the prerogative of purchasing stocks of the organization at a discounted price. Conceptually ESPP is like a Systematic Investment Plan or SIP. Here the employee has to contribute a part of his salary, between 1% and 15%, for a fixed period of time. Once this period is over and a corpus has been formed, the amount so accumulated can be utilized for purchase of the company's stock at a discounted price.

The discounted price which is applicable depends on the policy of the company. In some companies the lower of the prevailing price at the beginning or the end of the ESPP period is taken as the base price. The applicable discount rate applies to this price. If the price at the start of the period is Rs. 100 and at the end is Rs. 70, then the lower one or Rs. 70, is the base price. A discount of 10% on the base price will mean that the employee can procure the stocks at the rate of Rs. 63 per share.

Whether or not to purchase stocks as per the ESPP is dependent on the market standing and the long term potential of the company.

Conclusion: It is expected that the terms RSU, ESOP and ESPP have been fairly illuminated so that new employees do not grope around in the dark.  

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company.