Employee Incentive Schemes can be a great way for employees to gain financial benefits from their employer.
Employee stock options are an increasingly popular compensation tool used by employers to reward and retain staff by companies. With the right information and a thorough understanding of how they work, employee stock options can be a great way for the company to build wealth and secure future and present talents.
Employee incentives can also provide ownership in the company, which can help to motivate and retain them (to work towards the company’s goals). This can be an important factor in attracting top talents too.
Different Types of Employee Stock Options
Phantom Shares Option Plan
PSOP or “phantom shares option plan” grants an employee the right to receive a cash payment instead of becoming shareholders which will be paid at a designated time or in association with a designated event in the future. These plans normally grant a right to receive cash payments proportional to the price/value of the granted shares.
Employees participating in the plan generally receive cash bonuses of an amount based on the growth in value of the company. There are no specific legal requirements. Consequently, it will be the liability of the company to draft the PSOP agreement with additional diligence. PSOP are therefore legally similar to a bonus, but they track the value of the company instead of individual performance.
Hence, employees under PSOP have shared mutual interests with the shareholders.
Employee Stock Option Plan (‘ESOP’) and Employee Share Ownership (‘ESOW’)
ESOP gives an employee the right to purchase shares in a company at a pre-determined price within a specified period. An employee who is granted share options by an employer will be taxed on any gains or profits arising from exercising the share option.
ESOW plans allow for an employee to own or purchase shares in the company or in its parent company. They include share awards and other similar forms of employee share purchase plans (excluding phantom shares and share appreciation rights).
ESOPs and ESOWs are contractual agreements between employees and companies. They can be granted to selected employees on a discretionary basis. In some cases, the plan can include selling restrictions to prevent an employee from selling shares acquired through an ESOP/ESOW before a future event occurs or a certain period elapses.
Unlike PSOPs, ESOPs and ESOWs have clear legislative requirements. An ESOP or ESOW allows the company the flexibility to grant the plan on a discretionary basis and decide on the conditions, number of shares etc. However, the setup is complex and involves following rules and regulations.
Stock appreciation rights plan
SARs or Stock Appreciation Rights are a type of employee compensation linked to the company’s stock price during a predetermined period. SARs are a benefit for employees when the company’s stock price rises. Employees do not have to pay the exercise price with SARs. They receive an increase in stock or cash, which provides additional flexibility.
The primary advantage of SARs is that employees can receive extra benefits without buying stock. SARs are similar in some ways to phantom stock. The major difference is that phantom stocks are typically reflective of stock splits and dividends.
Setting up an Employee Incentive Schemes
Understanding how employee stock options work can be a complex process, and there are many resources available to help. But the most important is to work with a professional to ensure that the plan meets the company’s objectives and is compliant with the applicable laws and regulations.
Moreover, tax implications will not be the same for the employee. In this case, it is also recommended to understand the tax consequences of each schemes.
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