Basics of ESOPs Series 6

In Volume 5 of The basics of ESOPs, we talked about the exercise of ESOPs. In this volume, we will tackle all you need to know about liquidity options.

What are 'Liquidity options'?

Liquidity options may be categorized according to whether the compensation is share- or cash-based, and whether the value of the liquidity option is derived from appreciation or its full value.

- Cash-based plans avoid diluting of shares as no real shares are being transacted

- For example, using SARs allow you to benefit from appreciation of company shares without giving you the actual share. This is often used by family-owned companies

The liquidity alternatives most commonly practiced in Singapore In Singapore, options are prevailing in terms of the type of instruments used. RSUs are declining in importance because no performance metrics are attached, with the employee simply waiting out of the vesting period.

The liquidity alternatives most commonly practiced in India In the past 6 months, one of the common practices in India is that the ESOP scheme/trust extinguishes the granted option and the company does a valuation that happens at the prevailing share value. The cash amount is given to the employee as a cash bonus/salary top-up, so there is no exercise of shares and no entry into shareholder territory.

Can ESOP liquidity options where the granted options are extinguished also be replicated in Singapore? Yes. This can be done by combining features of the LTIPs together, by allowing exercise but with a buyback on the same day. In effect, this is a cash transaction from company to employee, but paper-work wise there will be a transfer of shares from company to employee and back from employee to company.

From a tax perspective, this would look like a salary top-up/bonus.

Are there provisions for buyback or to extinguish the grant without any issuance of shares in Singapore? This is not common as it is difficult for company and the employee to agree on the valuation of the options (e.g. The company may choose to value options using the Black-Scholes model but the employee might disagree). The valuation of an actual share is easier such as through using the last funding round valuation, which would be accessible to most team members.

Keep watching this space for everything related to ESOPs.