When it comes to offering Employee Stock Options Plans (ESOPs) to your Employer of Record (EoR) employees, there are several options available beyond the typical Non-Qualified Stock Options (NSOs). While NSOs are often the preferred option for EoR employees, companies might want to explore alternative equity compensation tools that can be better suited for their unique needs or those of their employees. In this blog, we’ll explore a few other ESOP options: Restricted Stock Units (RSUs), Stock Appreciation Rights (SARs), and Phantom Stocks, and understand how they differ from NSOs and why they may or may not be ideal for EoR employees.
1. Restricted Stock Units (RSUs)
What Are RSUs?
Restricted Stock Units (RSUs) are a form of equity compensation where the company grants employees stock units that vest over time. The key difference between RSUs and stock options is that RSUs are awarded free of cost to employees, and they don’t require any purchase or exercise of options.
Once the RSUs vest, employees receive company stock directly. The value of these units on the vesting date becomes the employee's income, and they are required to pay income tax on this value.
Pros and Cons of RSUs for EoR Employees
Pros:
- No Purchase Required: Employees don’t need to pay any exercise price, making it an attractive offer.
- Simple Structure: Unlike stock options, RSUs don’t require employees to make any exercise decisions, reducing complexity.
Cons:
- No Immediate Liquidity: Startups might not offer immediate opportunities to sell the stock, making it less appealing to employees who may need quick liquidity.
- Taxation at Vesting: Employees must pay taxes on the value of the RSUs when they vest, which might be difficult to manage if they cannot sell the stock immediately.
Due to these challenges, RSUs are generally less popular with EoR employees in startups, especially when compared to other options like NSOs or SARs.
2. Stock Appreciation Rights (SARs)
What Are SARs?
Stock Appreciation Rights (SARs) are a form of equity compensation where employees don’t receive actual stock but rather the cash equivalent of the stock’s appreciation over a period of time.
For example, if an employee holds SARs and the value of the stock increases from $5 to $15 during the vesting period, they would receive the difference of $10 as a cash payout. The SARs are a cash-based reward that mirrors the company’s stock appreciation, but the employee doesn’t actually own any shares.
Pros and Cons of SARs for EoR Employees
Pros:
- Cash Payout: Employees can receive cash instead of shares, which provides immediate liquidity and avoids the complexities of stock management.
- No Upfront Costs: Like RSUs, there are no purchase requirements, which can be attractive to employees who don’t want to invest their own money into the stock.
Cons:
- Taxation: The payout from SARs is considered ordinary income and is taxed accordingly, which may result in a higher tax burden for employees.
- No Ownership: Since employees don’t actually receive company stock, SARs don’t provide the sense of ownership that other stock options or equity plans might.
SARs are typically designed for cash payout rather than stock ownership, making them a more liquid, though less ownership-oriented, option for EoR employees.
3. Phantom Stocks
What Are Phantom Stocks?
Phantom Stocks are similar to SARs in that they don’t involve the actual issuance of company stock. Instead, employees are promised a future payout based on the value of the company’s stock. However, unlike SARs, the entire value of the stock—not just the appreciation—is considered the employee's income when they exercise the phantom stock.
For instance, if an employee is granted 1,000 phantom shares valued at $5 each at the time of the grant, and later the stock value rises to $15, the employee would receive the equivalent of 1,000 shares worth $15—a cash payout based on the full stock value.
Pros and Cons of Phantom Stocks for EoR Employees
Pros:
- Full Value Compensation: Employees receive the full value of the stock rather than just the appreciation, which can lead to a more substantial payout.
- Immediate Liquidity: Like SARs, phantom stocks offer cash payouts, ensuring employees don’t face the liquidity challenges associated with holding physical stock.
Cons:
- Taxation: The payout from phantom stocks is considered ordinary income, and employees are taxed on the entire amount of the payout when it is exercised. This can result in a high tax burden.
- No Stock Ownership: Employees don’t actually own the stock, which means they miss out on potential voting rights or dividends, unlike stock option holders.
Phantom stocks are an appealing choice for companies that want to offer equity-like rewards but don’t want to deal with the complexities of stock issuance or create dilution. However, they come with similar tax challenges to SARs and lack the true ownership benefits of traditional stock options.
Which Option Is Best for EoR Employees?
Each of these equity compensation tools—RSUs, SARs, and Phantom Stocks—has its own set of advantages and challenges. For EoR employees, the choice of equity compensation tool largely depends on the company’s goals and the specific needs of the employee base:
- RSUs can be a good option if the company is ready to offer employees stock without requiring them to pay anything upfront. However, they are less effective in startups where liquidity may not be readily available.
- SARs provide an attractive cash-based incentive that mirrors stock appreciation, making them ideal for employees who prefer cash over stock ownership.
- Phantom Stocks offer a similar benefit to SARs but with a larger payout based on the full stock value. They are useful for companies that want to provide equity-like rewards but without issuing actual shares.
Ultimately, it’s important for startups to carefully evaluate which equity compensation tool aligns best with their business model and employee preferences. Partnering with an Employer of Record (EoR) provider can help navigate the complexities of offering these plans, ensuring compliance and streamlining the process for global teams.
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