After working hard in your career for the past 15 years, you’ve earned a well-deserved promotion to a senior level in the company. As you read through the promotion letter, aside from the expected pay increase, you notice something new: a page about becoming a company shareholder, with unfamiliar terms like ESOW, ESOP, RSU, ESPP, and vesting periods.
There’s a sense of pride in having the opportunity to become not just an employee, but an owner who can contribute more to the company’s growth. But understanding how these schemes work and how to manage them can be confusing.
Understanding Employee Share Plans
So, how do these share plans work? Typically, the purpose of offering employee shares is to align the company’s interests with those of the individual. If the company performs well, the share price rises, benefiting the employee who is also a shareholder. This arrangement also encourages a greater sense of ownership and motivation among employees.
A company can award shares to an employee through Employee Share Ownership Plans (ESOW), which can be done in several common ways:
Employee Stock Purchase Plan (ESPP) – Usually the first offering accessible at a junior level, this benefit allows employees to buy company shares at a discounted rate, typically 10% to 15% below market value, up to a certain amount. If an employee enrols, the purchase can often be facilitated through a monthly payroll deduction. Even if you end up selling off the shares shortly after, it’s still advantageous to benefit from the discount.
Employee Stock Ownership Plan (ESOP) – Once employees reach a certain level in the company, they may be offered an ESOP. A bit more complex, this stock option grants you the right to buy company shares at a pre-determined price. You profit when the market price is higher than the exercise price. However, there’s typically a vesting period during which you can exercise your options in different tranches, spread over three to five years. This vesting period also serves to retain talent since employees usually forfeit any unvested shares if they leave the company. Keep in mind, that your gains will depend on the market price being higher than your exercise price, and that gain will be taxed in the year of vesting or when any sales restrictions lift.
Restricted Stock Units (RSU) – As part of the total compensation, employees might be offered company shares in addition to their regular salary and bonuses. Unlike ESPP or ESOP, you don’t have to pay anything to receive these shares, although they usually come with certain conditions, such as performance. Like ESOP, there is usually a vesting period, and if you leave before the shares vest, you typically forfeit any remaining unvested shares.
Other schemes include Performance Share Plans (PSP) which reward long-term performance with shares, typically reserved for senior executives, and Phantom Share Schemes where the benefits are settled in cash instead of actual share ownership.
Considerations for Managing Shares
Although the mechanics of these schemes vary, they all share one characteristic: you’ll own company shares as part of your compensation. Therefore, what should you consider when managing these shares?
Taxes – Just like your salary, shares received are also subject to tax. Different considerations apply to how your shares are taxed, but generally, whenever and however much you gain, that will be taxed.
Let’s use an ESOP as an example. In a typical work year, you’re granted a certain amount of stock options as part of your compensation. These options will vest over the next five years. At the time of granting, you’re not taxed because you don’t technically gain anything yet. Once your stock options vest, you can exercise the option. If the current share price is higher than the price stated in your option, your tax liability for that year will be the difference between the value of the shares you can acquire and the amount you have to pay to exercise the option. This is because you can immediately benefit in cash terms if you exercise the options and sell the shares in the open market.
Conversely, any shares directly awarded to you without a vesting period will be taxed at their total market value.
It’s important to remember that your tax liability is locked in when you receive the shares, but their value can fluctuate depending on market conditions and the company’s performance. This means there’s a possibility that if the shares’ value decreases significantly, you could face a large tax bill that doesn’t align with the actual amount you receive.
Therefore, it’s a good idea to sell off the amount equivalent to your tax liability in shares to ensure you can always pay your taxes when due.
Concentration Risks – Often, executives can end up with high concentration risks in their company due to their strong beliefs in its future prospects. Their regular paycheck, remuneration, and personal wealth in the form of shares are all dependent on the company’s performance, which compounds concentration risks. While concentration in the right company can potentially make an individual wealthy, it also comes with a lot of risks. Therefore, it’s important to diversify away from holding too much in your company shares.
To strike a balance, one can consider setting a limit in terms of company shares to hold, such as only having 5% to 10% of one’s total asset, and selling off the rest beyond that limit to be reinvested into a globally diversified portfolio. The same would apply to any additional new remuneration that gets awarded or vests.
Vesting Period – Companies often implement vesting conditions to incentivise employees to stay and encourage loyalty. If you intend to stop working before the official retirement age, you should be prepared to lose a portion of unvested share remuneration upon your resignation. Hence, when planning for your retirement capital, you should take that into account and not assume those assets will contribute towards your retirement.
In Conclusion
This should provide you with a good understanding of how to think about and manage company shares, whether you are just starting to receive them or have already been doing so.
Managing company shares requires careful consideration aligned with your overall wealth and long-term plans. There’s no one-size-fits-all approach, so tailor your strategy to your priorities. Be proactive in understanding and managing your employee share plans.
This is an original article written by Tan Chin Yu, Lead of Advisory Team at Providend, the first fee-only wealth advisory firm in Southeast Asia and a leading wealth advisory firm in Asia.
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