Stocks and Shares – Know the Difference

​If you’ve recently started a new job and find terms like ESOP, RSU and phantom shares in your employment contract, you might be feeling a little baffled.

Don't worry! You're not alone. We guarantee that there will be many others out there that share the same confusion.

Before we break down these terms to understand exactly what you are signing up for, let’s start with why equity could matter to you.

First and foremost, if you hold shares or have a partial ownership stake in the company, it's in your best interest for the business to thrive and expand. Your positive contributions to the company could help boost its profitability, which in turn could elevate the stock value—resulting in a $$$ win-win for you.

Some companies provide equity as a bonus element on top of an already attractive salary and benefits package.

In some instances, the company might offer substantial equity as part of your overall compensation, which could mean a reduced salary. This is particularly common in startups, which often depend on initial funding rounds and might have limited cash reserves. However, this arrangement could prove advantageous for you in the long run if the company experiences significant growth over time.

The Who, What, Pro’s and Con’s

ESOP, RSU, and phantom shares are our focus for today!

ESOP (Employee Stock Ownership Plan)

What it is: An ESOP in a nutshell is where an employee has the option to own shares in the company. It can act as retirement plan that allows employees to become partial owners of the company by holding its stock. Companies may contribute shares directly to this plan, match employee contributions or both. Usually, you will have to wait a certain amount of time before you can use your stock options. After that, you can choose to buy company shares at a set price. This set price is what you'll pay to turn your stock options into actual company shares.

ESOPs are set up by trust funds and are used by companies of all sizes including large globally recognized corporations.

Pros:

- Aligns employee and company success.

- Offers a form of retirement savings.

- Potential for substantial long-term gains if the company performs well.

- Help employees feel more appreciated and better compensated.

- Less admin and legal hassle that RSUs and Phantom shares due to standardized t&c’s.

Cons:

- These shares are meant to be sold only at or after the time of retirement or termination and the employee is remunerated by receiving the cash value of their shares.

- Concentrates retirement savings in a single asset, which can be risky.

- Usually comes with a vesting period, which means you can’t cash out immediately.

- The opposite to our pro; a potential for loss if the company doesn't perform well.

RSU (Restricted Stock Units)

What it is: RSUs are promises to give you shares of stock at a future date or upon meeting certain performance goals. They are usually subject to a vesting schedule, meaning that you will usually have to wait a certain time or achieve specific goals to fully own these shares. Unlike stock options, RSUs don't have a set price you need to pay to get the shares; they're given to you directly.

Pros:

- Typically, no upfront cost to the employee.

- Often less risky than stock options, as they have value even if the stock price declines.

- You're given a set number of shares that become yours after a vesting period. There's no need to decide when to exercise the option or pay an exercise price, making them simpler than stock options.

- Once the RSUs vest, they have immediate value you can sell them (pending company restrictions) or hold on to them.

Cons:

- Taxed as income when they vest, which can be significant.

- No voting rights in the company until the units convert into actual shares.

- You are restricted in the sense that you don't own the stock outright until it vests, which usually depends on you staying with the company for a certain period or meeting performance milestones.

Phantom Shares

What it is: Exactly what it says on the tin. Phantom Shares are like a promise between the company and the employees. Employees get a cash bonus based on how well the company's stock is doing, but they don't actually get any real stock. It's more like a special perk than owning part of the company.

Just like RSUs and stock options, Phantom Shares often come with rules. You might have to stay with the company for a certain time or meet specific goals to get this bonus.

Pros:

- Employees get the financial benefits of share ownership without actually owning shares.

- Usually not subject to stock market volatility.

- Simple and clear, you get a cash bonus based on the company’s stock performance.

Cons:

- No voting rights or dividends, as you don't actually own the shares.

- Tax implications can be complex. Phantom shares are often taxed as income as it is a cash award. Employees may face a higher tax burden on their financial gains in comparison to RSU and ESOP.

- Your bonus is tied to the company's performance. If the company doesn't do well, your bonus might be lower or non-existent.

- You miss out on benefits of actual stock ownership.

Understanding these different forms of equity can help you make informed decisions about your compensation and investment strategies. Make sure to consult a financial advisor to discuss which option or combination of options best fits your financial goals.

Disclaimer: This article is for informational purposes only and should never be considered financial or legal advice. All content is based on own opinions.

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