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Employee Stock Option Plan

What is Employee Stock Option Plan?

Employee Stock Option Plan (ESOP) in simple meaning refers to the plan/ scheme brought in by the company in accordance with the Acts and regulations for the participation of the employees in the ownership viz. Equity ESOP shares of the company at a pre-determined price. It is a kind of benefit plan for the employees to become the owners of the company and also serves as an important tool to attract and retain talent in the organization.

In today’s scenarios, Startup ESOP/ESOP in a startup is significantly gaining popularity over a period of time, since the business is at an initial stage would rather strive for implementing these schemes so as to retain talented employees and also considering the fact that burden of paying huge salaries to the employees can be neutralized by bringing in such motivated benefit plans and rewarding the employees for their contribution to the business of the company.

Employee Stock Purchase Schemes (ESPS), Employee Stock ownership plan, Employee Stock Options Scheme (ESOS, etc.) are some of the major employee compensation plans adopted and formulated by corporates in India.

Benefits of ESOP

For Employees

  1. Since the Equity shares refer to the Ownership in the company, employees can become part of the company’s success over a period of time.
  2. As per these plans, generally, shares are given at a pre-determined price, hence the employees can stand to benefit by selling the shares at a future point of time.
  3. These schemes carry great motivation for employees to perform and grow with the company.

For the Company

  1. Leverage employee’s morale urging them to perform better in their day-to-day tasks
  2. Boosts employee retention and thereby lowers turnover rate
  3. Savings on director remuneration for a private limited company as a part of salary by offering a certain portion of ESOPs.

Company's Considerations for ESOP

There are lots of points to be considered and accordingly evaluated before bringing in such schemes viz.

Company's consideration for ESOP

Procedure & Compliance of ESOP

The legal framework that governs the formulation of ESOP in India are:

  • The Companies Act, 2013
  • The Companies (Share Capital and Debentures) Rules, 2014
  • SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999, and
  • SEBI (Share Based Employee Benefits) Regulations, 2014
Procedure & Compliance of ESOP

ESOP Scheme Implementation

ESOP scheme implementation

1. Formulation of the ESOP scheme

It is important to draft the scheme in accordance with the company objectives for the formulation of these plans. Various points are required to be considered viz. Quantum of the issue and proposed offer to selected employees, Price for shares, etc.

2. Shareholders’ approval

Post drafting, the ESOP Policy/Scheme is required to be approved by the shareholders of the company at their meeting. Prior to June 5, 2015, the approval for this scheme needs to be obtained by a ‘special resolution’ and filed with the Registrar of Companies. But now with above mentioned dated notification, the private limited companies need not comply with this rule and in such cases simple Ordinary resolution can be passed by this Company.

3. Granting options to employees

After approval of the ESOP scheme in a shareholders’ meeting, the second step is an issuance of a ‘Letter of Grant’ to the concerned employees. This letter contains important details about the number of options granted, the vesting period, the calculation of the exercise price, etc. This will have all the written information about the options like several granted options, exercise period, vesting exercise period, etc.

Valuations of shares are also required to be done at the time of “grant of Option” by a registered valuer and “exercise of option” by a Merchant Banker. Therefore, valuation is to be done every time when the options are granted and /or exercised. Generally, valuation not older than six months is considered to be valid.

4. Exercise by the employees

Now, after receiving ‘Letter of Grants’, an employee can then opt for the ESOP option via the ‘Exercise Application’. Accordingly, on receiving the application by the company, it is required to conduct a Board meeting by the company in accordance with Company Law and regulations for the issuance of these shares to the employees.

Also, the company needs to give disclosure in its Boards’ Report regarding the ESOP shares issued by the company as per the specified guidelines.

The register is required to be maintained under the concerned Rules at the registered office of the company and shall be duly authorized by the Board on respective entries.

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FAQ's related to the ESOP Services

Q.1 What is ESOP?

ESOPs or Employee Stock Option Plan is an employee benefit plan where the employers offer their employees ownership interest in the organisation. The employer has the discretion to decide who is eligible for these stocks. ESOPs can be issued as profit-sharing plans, bonuses, or direct stock. In India, several laws and regulations govern the issuance of ESOPs. These options can be purchased before the excise date.

Q.2 While issuing ESOP, what are some of the disclosures the company needs to make?

For passing the resolution for the issuance of ESOP in the explanatory statement, the company has to make several disclosures. These are-

  1. The number of stock options that the company will grant.
  2. Which employees are eligible to participate in the issuance of ESOPs.
  3. The company needs to disclose the requirements of the vesting period of ESOP.
  4. The company would have to disclose the maximum vested period for the options.
  5. The company will disclose the exercise price of the ESOPs and the process of exercise.

Q.3 What are the three stages of ESOP allotment?

Allotment of ESOP is categorized into three stages-

  1. Grant- Grant is the first stage of ESOP allotment. In this stage, the company will inform the employees that they are eligible for ESOP. The company has complete control and freedom over determining the exercise price while issuing the options to the employees.
  2. Vest- In this stage of ESOP allotment, the employees can apply for the shares they are granted. According to the legal framework governing ESOP, a gap of a minimum of one year should be provided to the employees between granting them the option and vesting of the option.
  3. Exercise- The last stage of ESOP allotment is exercise. In this stage, employees can exercise the right of buying the options. Until the shares are issued on exercise of the option, the employee does not have any right to receive dividends, vote, or enjoy shareholder’s benefits.

Q.4 Who is eligible for ESOP?

According to the Companies (share capital and debentures) rules, 2014, the following employees are eligible for issuance of ESOP-

  1. An employee who is either working in India or outside India and is working permanently with the company.
  2. Directors of the company, who are either whole-time or part-time directors, are eligible for ESOP. However, ESOPs will not be issued to independent directors.
  3. Directors or permanent employees of associate companies, holding companies, or subsidiary companies operating within or outside India are eligible for ESOPs.

Q.5 What are the benefits of ESOP for the business?

There are several benefits of ESOP for the business. These benefits are-

  1. Increased Productivity- Since ESOP recognizes strong employee loyalty, they act as an incentive for the employees to improve their performance and productivity and give them a sense of ownership.
  2. Tax advantages- Issuance of ESOPs to the employees has several tax benefits for the business as well as the employees. This is because the contributions made to the ESOPs are tax-deductible, and the employees are not taxed on the ESOP contributions they receive.
  3. Consistency in governance- Usually, when an owner of a company steps down from the business, there is a worry of change in governance. However, companies with ESOP in place don’t have to worry about this change.

Q.6 When should a company consider implementing ESOPs?

A company should consider implementing ESOP after consulting with experts from ESOP services and considering and understanding intricate legal and tax complexities. The company should also evaluate that its business is expanding and has a stable cash flow that can support ESOP implementation.

Q.7 In India, what is the legal framework that governs ESOP?

Several laws and regulations in India govern ESOP. The legal framework that governs the formulation of ESOPs in India are-

  • Securities and Exchange Board of India (SEBI) Share-based employee benefits regulations of 2014.
  • The companies (share capital and debentures) rules, 2014.
  • Share and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines of 1999, and
  • The companies act of 2013.

Q.8 Which employees are not eligible for exercising ESOPs?

According to the Companies (Share capital and debentures) rule, 2014, the following category of employees are not eligible for exercising ESOPs-

  1. If a director holds more than 10% of the equity shares in a company, either directly or indirectly, either himself, through a relative, or a third corporate body is not eligible for ESOPs.
  2. An employee who either belongs to the promoter of the company or is part of the promoter group is not eligible for exercising ESOPs.

Q.9 What are the different types of employee stock option plans?

The following four are the different types of employee stock option plans available to employees-

  1. Employee stock purchase plan- In the Employee Stock Purchase Plan, the company offers options or shares to their employees at a rate that is lower than the fair market value.
  2. Employee stock option scheme- In the Employee Stock Option Scheme, the company offers shares or options to their employees based on performance metrics. The shares offered under this scheme are constrained by a vested period and a predefined valuation.
  3. Restricted stock units- The company grants restricted stock units after an event.
  4. Stock appreciation rights- Under stock appreciation rights, if an employee meets a prerequisite condition, then the company will offer them cash.

Q.10 What are the benefits of ESOP for the employees?

The benefits of ESOP for the employees are-

  1. For the employees, ESOPs provide job security and job satisfaction.
  2. The employees feel more responsible and show more initiative and better performance because they become a part of the decision-making process.

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