Right shares and ESOP are terms used in Stock markets. Companies do require funds and at times reserves and profits earned do not seem to be enough while expanding business. This is where Right shares and ESOP do their job.
Right Shares vs ESOP
The main difference between Right shares and ESOP is that they target two different stakeholders. Right shares tend to target the already existing shareholders of the company. Whereas, ESOP targets the employees.
Right shares of a company’s existing shareholders sanction them to buy additional shares directly from the company in proportion to their existing shareholding but at a discount to the current market trading price. Whereas, ESOP is a choice of buying the shares of the employer at a price decided beforehand given to the employees leaving them at a current Market price of the Employer’s shares sold in the stock market.
Comparison Table Between Right Shares and ESOP (in Tabular Form)
| Parameter of Comparison | Right Shares | ESOP |
|---|---|---|
| Buyers | Right shares are given only to the shareholders of a company, and not to the employees of the company. | ESOP is provided only to the employees and is not concerned about the shareholders or even the general public. |
| Purpose | Rights shares are given to their shareholders when they require expanding the company or just require working capital. | ESOP is given to the employees as incentives and to make them happy ensuring them to stay in the company for a long period. |
| Shares to be sold | In the case of the right shares, the shareholder can immediately sell the shares at the available market price since they are credited much faster in the accounts of the shareholders. | In ESOP, there is a lock-in period ranging from 5 months to 10 years, which prohibits the employees from selling the shares immediately. |
| Listed companies | Only listed companies are allowed for Rights share. | ESOP allows both listed and unlisted companies. In the case of an unlisted company, ESOP gives an option to their employees of exercising their rights, whenever promoter is selling their company to other listed ones. |
| Comparison | Right shares are analogous to an ATM, where cash is available readily. | ESOP is analogous to fixed deposits which mature after a certain period. |
What are Right Shares?
Right shares are the ones that are issued by the company following the issue of the original shares but at a discounted price rather than buying in the Secondary market, as stated in the 81(1) of the Companies’ Act, 1956.
The offer of the Right shares is made in the form of a notice stating the details of the shares offered to limit to a span of 15 days, and if the existing shareholders fail to accept the offer within that span, these shares are given to new members. The quantity of shares bought depends upon the existing holds of the shareholders.
Features of Right shares:
- When companies wish to expand their business, or need cash for various other objectives they tend to undertake Right issues.
- Right Shares give the existing shareholders a preference to buy the shares at a discounted price on or before a specified day.
- The shareholders appreciate the right to exchange with other market contestants until the date of purchasing new shares.
- The right shares are traded in the same way as equity shares.
- Existing shareholders can ignore the rights but in that case their existing shareholding would not remain after the issue of the additional shares.
Reasons for a Rights Share:
- When the company is expanding its business, it will require a huge capital amount. To raise that amount of capital, a rights share is a faster way rather than opting for a debt.
- Companies often get projects where debt/loan is not suitable, or might not be available, or maybe even expensive. In those cases, to raise funds, the company undertakes the Right shares.
- To improve the debt-to-equity ratio, or even looking to purchase another company, the companies opt to raise money via Right shares.
- To clear off existing debts, companies opt to issue their shares and improve financial health.
What is ESOP?
To begin with, ESOP is the abbreviation for Employee Stock Ownership Plan. An Employee Stock Ownership Plan is a plan made to benefit the employees giving them an ownership stake in the company. The employer gives a portion of the company’s shares to eligible employees at zero upfront costs. Eligibility of employees depends upon their pay scale, terms of service, or some other similar factors.
The shares for ESOP are held in a trust unit until the employee resigns or retires from work. After their term of service, the company buys the shares back to further allocate among other employees.
The procedure of work:
- Prior to starting an ESOP, the company should create a trust to contribute to new shares or cash to purchase existing ones. These contributions remain tax-free up to certain limits.
- The shares of an ESOP are required to be vested before distributing to employees. Vesting refers to increasing rights employees get on their shares based on seniority in the organization.
- After that, the shares are distributed to the accounts of the eligible employees.
Benefits of ESOP:
- Tax benefits- Employees need not pay taxes in contribution to an ESOP. They are taxed only when they exit or after retirement. Any profits made during the time are taxed as capital gains.
- Improved way of managing employees- Companies having ESOP are seen to have better employee involvement. It tends to improve employee awareness and also increases their trust in the company. ESOP allows employees to see the bigger picture of the company’s plans and give suggestions to any decision made.
Main Differences Between Right Shares and ESOP
- Right shares of a company are issued by the listed company in which shareholders buy shares at a discounted price. Whereas, ESOP is a plan which gives the advantage to the employees and provides them with a portion of the ownership stake in the company.
- Only shareholders of a company are provided with the right of shares. Whereas, ESOP is a service available only to the employees and does not include the shareholders or even the general public.
- Companies mainly issue their right shares when they need capital for several objectives. Whereas, companies provide ESOP to its employees when they can’t provide a handsome salary, but want to keep the employees contented. ESOP encourages a better workforce and increases the employees’ trust in the company.
- The shares can be immediately sold in the current market price in the case of the right shares because they are credited much faster in the accounts of the shareholders. Whereas, In ESOP, employees are prohibited from selling the shares immediately due to a lock-in period of 6months to 10 years.
- Right shares can be calculated theoretically. To find out the value of rights, let us assume a stock price of a share to be $50 and subscription price to be $40 and four rights are needed to buy one share, then price of one right would be=$(($50-$40)/(4+1))= $2. Whereas, the perquisite value is calculated for ESOP.
Conclusion
As it is visible from the above points, the prime objective of both Right shares and ESOP is to raise money for the company, but they differ from each other in various ways. One should note the requirements of his/her company and opt for the suitable way.
ESOP is doled out by employers to retain talent or incentivize them.
Usually the vesting period is kept longer so that the employee sticks around for a longer period and this is done to retain the employee. On the contrary if it is used to incentivize then the exercise price is kept very low so that the employee can benefit from the acquisition of the shares.
On the other hand Rights shares serves a different purpose altogether. Usually, cash-strapped companies in troubled times resort to rights issues to raise money when they badly need it.
References
- https://www.bvreview.org/doi/pdf/10.5791/0882-2875-18.3.100
- https://search.proquest.com/openview/96870bf38020de8f9cc5a486e7e40fc7/1?pq-origsite=gscholar&cbl=41798