Equity pay, like stock options or restricted stock units (RSUs), maybe one strategy to cut ongoing expenditures and give staff non-cash compensation throughout the early phases of a company’s development.
Startup companies frequently use this technique since they cannot afford to pay hefty rates. They typically add some kind of stock reward in their job offers to be more competitive in attracting talent and motivating employees.
Employees may get non-cash compensation in a variety of ways which are all classified as equity remuneration or often also known as stock compensation or share-based compensation. Employees that receive this benefit typically end up owning stock in the business, which means they share in the profits.
Equity remuneration is, in general, a fantastic approach to developing a committed relationship with employees. For instance, in 2017, Amazon gave its 565,000 employees share-based remuneration worth around USD$4.3 billion.
In this blog post, we’ll go over the most prevalent stock compensation options for private businesses. Although comparable, these forms of equity could ultimately have differing effects on your Singapore company. To assist you in selecting an appropriate structure when incorporating your Singapore company, we shall outline how they are different.
Stock Options and Restricted Stock Units (RSU): Their Definition and Applications
A stock is a type of financial instrument that denotes ownership of a certain percentage of a business. The number of shares possessed determines the level of ownership. The ownership of shares may entitle the holder to an equivalent share of the company’s assets and profits, depending on the type of shares held.
You might be able to exercise your right to vote at shareholder meetings, receive dividends, or sell off your shares if you own any stock. Dividends are essentially derived from the company’s profits. Your voting power increases with the proportion of shares that you possess. Such rights allow a company’s stock to have value and be traded based on that value.
Restricted Stock Units: What are They?
Restricted stock units are a type of equity reward that, though having some restrictions, reflects genuine ownership of a company’s stock. The typical purpose of restricted stock units is to motivate employees by giving them a stake in the business for which they are working.
Ownership restrictions typically take the form of a vesting schedule or performance criteria that must be satisfied for the receiver to secure full ownership rights in the stock.
Restricted stock units are frequently given out at the beginning phases of a business when the company has not yet established itself and when the stock value is low. Giving employees restricted stock units becomes increasingly challenging and detrimental to the company as it grows and its stock becomes more valuable.
Why are Restricted Stock Units Issued?
Giving restricted stock units to employees can shield you against the premature sale of your company’s stock, which could hurt your business or your control of the business because stockholders cannot sell their stock before a specific occurrence (which typically takes several years).
Additionally, it serves as a strong retention tool that encourages staff to stick with the organisation until certain goals are achieved. Employees may be required to forfeit ownership of the restricted stock units if they ultimately decide to quit the company or fail to achieve the company’s established goals.
The corporation has the option to repurchase some unvested shares in this situation based on their nominal value. This legal tool will assist you in maintaining control within the business and preventing the transfer of ownership to former employees or other parties with no desire to see the expansion of the business.
Give restricted shares to your staff with caution because they might engage in decision-making processes that have a direct impact on your company’s operations. Executive managers or directors should be the ones given restricted stock units since they are more likely than average employees to stay with the company for a longer period.
Stock Options: What are They?
Another type of equity compensation is stock options, although, unlike restricted stock units, these grants only provide the owner with the right to purchase a set number of shares at a predetermined price on or after certain dates rather than immediate actual ownership in the company.
Before exercising this right, employees must have been employed by the company for a specified amount of time, and they must make their decision within that window of time, or the option will expire.
Additionally, vesting schedules that restrict the employee’s ability to exercise stock options can be included in stock option grants. Employees can be allowed to exercise their stock options in several ways.
Why are Stock Options Issued?
When you provide your employees with stock options, they gain certain advantages. By the time the options are vested, the stock’s fair market value should have greatly increased if the business is doing well.
Employees with stock options might make money off the discrepancy between the exercise price and the market price on the exercise day. Therefore, if the value of the company has increased, employees also stand to benefit.
Employees are not putting anything at risk until they exercise their stock because they are not putting any money down in advance. However, if the stock price stays at or falls below the option exercise price, stock options have a considerable likelihood of losing their value.
The fact that the employee receiving the option does not receive voting rights, dividend rights, or any other benefits that could come with typical stock ownership in a firm is one advantage stock options offer to the company.
Since an employee is not yet a shareholder when options are issued, any value in stock options is essentially hypothetical until they are exercised.
Additionally, giving stock options to employees is free for the business while still encouraging them to accept a lower salary.
Employees may receive 70% in cash and 30% in stock options, for example. By using this technology, businesses can free up money that can be used for other requirements of the company.
Stock Options and Restricted Stock Units (RSU): What Differentiates Them?
Stock options and restricted shares are two types of equity remuneration given to employees as incentives. Stock options are common among startups that have not yet gone public, whereas restricted shares are most frequently awarded by well-established businesses.
The company’s executives and directors typically receive restricted stock units, but stock options are more frequently given to regular employees.
The following points distinguish stock options from restricted stock units:
1. Date of Expiration
Employees should specify the time by which they would wish to exercise their stock options because most have expiration dates. Since restricted shares are issued after an employee has vested, they never expire.
2. Exercise Cost
Most of the time, the price corresponds to the stock’s fair market value at the time the option is granted. The employee’s share purchase price is this amount. There is no such thing as an exercise price for restricted stock units, which are issued directly to employees as shares and therefore do not require any conversion.
Unlike stock options, restricted stock units may give the owner the same privileges as other shareholders, such as dividend rights and voting rights.
4. Exercise Technique
This outlines the payment method for future option purchases by employees (e.g. cash or stock swaps). This doesn’t matter for restricted stock units because the employee does not need to purchase the shares.
5. Principles of Taxation
This phrase refers to whether restricted stock units are treated as preferred items with a reduced tax rate or as regular income and how they are taxed in comparison to options.
6. The Vesting Process
This is how stock options are acquired. In exchange for your continued employment after a set period, your employer may grant RSUs or employer-matched contributions. This serves as a reward to promote employee retention.
For Instance
The corporation issues one employee-restricted stock unit, which is vested after a year. Another employee received stock options, which are also vested after a year.
In contrast, the second employee will be permitted to purchase the stock at the exercise price after one year, while the first will automatically acquire the shares after one year (assuming the employee has stayed employed at the company for one year) if the employee is still employed at the company.
What Tax Rate Is Charged On Stock Options?
Gains from stock options are included in the income from work. The amount of income a person makes and whether they are considered Singapore tax residents or non-residents affect the tax rate that is levied.
A person’s income will be taxed at graded rates ranging from 4% to 22% if they are a tax resident. A non-tax resident will be taxed at a rate of 15% or resident rates, whichever happens, to be higher.
What Tax Rate Is Charged On RSU Gain?
From a Singapore perspective, non-US taxpayers who have already paid tax at vesting are exempt from additional capital gains taxes on growth. This provides you with the freedom to diversify into different investments as per your financial objectives and time frame.
Remember that the stock immediately loses value if shares are vested at a higher price; there will therefore be no adjustment made to the tax due that year.
Upon vesting, US taxpayers are subject to both US and Singapore tax obligations. Some businesses might allow you to use their “sell to cover” mechanism, which lets you sell 20% to 30% of the shares to cover the US withholding tax, thus reducing your tax obligations.
While some businesses provide the IRS with the necessary information on tax filings, others do not. If you’re a US taxpayer, keeping thorough records of your transactions is crucial.
For US taxpayers, diversification is far more strategically sound. Any gains from the selling of vested RSUs will be taxed once the shares are vested. Your holding period will decide whether subsequent sales are long-term or short-term, as well as the tax rate you will be subject to.
The last element to take into account is Singapore’s “deemed exercise” regulation. This mainly applies to foreign nationals, PRs who leave Singapore, PRs who are posted to work abroad, and PRs who change occupations in Singapore.
Your unvested shares will be considered vested by IRAS, and a single lump sum tax payment will be necessary. Taxes still need to be paid on a stock that you cannot access because it has not been vested. It’s crucial to prepare for this because paying the tax may demand a substantial sum of money.
What Is the Best Option for Your Company?
What kind of stock is best frequently depends on your objectives. The two key determinants of the business are:
- What the employee or other beneficiary wants, and
- Whether you want this individual to own stock and actively participate in the management of the business.
If you grant someone a stock option, provided they exercise the option and pay the price to buy the shares, they can become a shareholder. However, not everyone is eager to comply. In the end, you might have fewer stockholders because employees might decide not to exercise their options at all.
Employees that leave the company too soon, lack the resources to exercise their options, or simply don’t share the company’s goals may follow through with this. If you had given them restricted stock units, they would have been able to exercise their ownership rights and become stockholders.
However, whatever stock an employee has been vested with, he or she owns it and can easily walk away while still being a stockholder. What companies often will do is repurchase some unvested shares.
The Conclusion
When a business grants a worker the opportunity to buy company stock at a predetermined price and at a specific time, this is known as a stock option. If there is a vesting plan in place, this could happen in stages, as certain shares might become accessible each year over many years.
RSUs, on the other hand, are stock awards that a corporation offers to a worker without requiring any purchase. These are given to employees either as shares or their cash equivalent.
There are advantages and disadvantages to both, making the decision to choose between stock options and RSUs difficult. In general, it comes down to the fact that RSUs are less risky because there is no cost associated with obtaining the shares.
However, bear in mind that you probably won’t have an option if you’re an employee receiving either. Before deciding on your whole compensation package, it’s critical to understand what is being given to you and how it functions.
If you need more understanding of employee stock options or RSUs as an employer or want help with its taxation, you can connect with us to take care of all your accounting and taxation needs.
