Shubhika Sundriyal
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Editor's Note:-When building a thriving company, attracting and retaining top talent is key. In this blog, we dive into two equity-based incentives, ESOPs and sweat equity. This will help you choose the best option for long-term employee engagement and growth.
What do you do to help retain top talent in your company? Incentivize them with the right things! A medical cover? Absolutely. Work-life balance? Of course. Growth opportunities? Essential. But is there something that is even more powerful? Yes. And that’s equity-based incentives.
When it comes to equity-based compensation, there are two key options you might be considering - Employee stock option plan (ESOP) and Sweat equity.
ESOP and sweat equity are two equity compensation plans via which a company issues its shares to its employees. We’ll go through them one by one. Let’s get started.
An ESOP is an excellent equity compensation plan that allows employees to purchase company shares at a price lower than the current market value. The plan acts as an incentive above and beyond the typical monetary compensation and helps retain your best employees/directors in the long run.
Employees get the right to own their allocated shares after a vesting period. The allocation of these shares depends on various factors such as performance and tenure.
Why are ESOPs attractive? Because employees feel personally invested in the company. And why is that? Because there is potential for long-term wealth creation if the company’s stock value increases over time.
Why are ESOPs attractive?
Sweat equity is when the company issues actual shares to an employee/director, crediting the employee for their time, hard work, effort, and performance.
These shares are allocated immediately and do not come with a vesting period. These are given to employees so as to acknowledge their contribution to the company. Thus, it doesn’t come under their compensation package and must be deemed a reward.
Sweat equity shares are directly allotted and have no vesting period or conditions attached.
Next, let’s compare these two concepts across key aspects to get a better picture of what they imply.
Here’s a table outlining the key differences of ESOP vs. sweat equity. Take a look. It’ll help you get a fair idea about both and help you understand what will work best for your organization.
| Aspect | ESOP | Sweat Equity |
| Use Case | Structured approach to long-term retention | Great for incentivizing key contributors in the short term |
| Ownership | Option to purchase company shares in future after vesting | Immediate ownership |
| Risk Appetite | Stable | Risky |
| Allotment | Shares are allotted only after exercising the options post a vesting period | Directly allotted at a discount |
| When to Issue | No restriction on when shares can be issued | Can be issued after one year of commencement of business |
| Restriction on Issue | No restriction on issue of ESOPs | Sweat equity shares cannot be issued for more than 15% of the existing paid-up equity share capital or Rs. 5 crore, whichever is higher. |
As you review the table, you’ll notice that neither option is inherently better or worse. The key is finding the right fit for your business, one that aligns with your goals and helps you scale effortlessly.
Sweat equity is calculated based on the fair market value of the skills or time an individual gives to the company. The value is equivalent to the investment that the company otherwise would have made to hire a person with the similar expertise.
Sweat equity gives employees immediate ownership of the company shares. This acts as a strong sign of the company’s trust in their skills and efforts.
In ESOPs, there's a defined vesting schedule that requires employees to stay with the company for a fixed period of time. Whereas, in sweat equity vesting schedule, shares are allotted without any vesting schedule which gives immediate ownership of company shares.
The type of equity you choose to go for depends on your goals. If you're looking for long-term employee retention, ESOPs are the way to go. But if you're looking to reward an employee immediately, sweat equity is your best bet.
Sweat equity shares have some regulatory limits. They cannot exceed 15% of the paid-up share capital or Rs. 5 crore (whichever is higher). On the other hand, ESOPs don't have such restrictions.
When it comes to company control and equity, ESOP holders have limited or restricted access to it. But since sweat equity share holders get immediate access to their shares, they enjoy instant equity and decision-making power in the company.
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