How to put in place an ESOP?
Employees are very integral for a company’s well being and prosperity. Employers often make profound efforts and adopt various mechanisms to motivate and retain their workforce, one such measure that has been gaining popularity is EMPLOYEE STOCK OPTION PLANS or, ESOP. Compensating employees with ESOP is a win-win for both the employer as well as his employees.
What is Employee Stock Option Plan or ESOP?
ESOP is gaining popularity amongst Start-ups who, in their initial stage of business cannot afford to pay huge amounts of money as salaries. Simply speaking, ESOP is an incentive based scheme devised by companies aimed at motivating employees by giving them an option to buy shares of the company at a predetermined price and period. It is purely optional and not a compulsion upon the employees.
The legal framework that governs 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
Employee Stock Option Schemes (ESOS), Employee Stock Purchase Schemes (ESPS), Retirement Benefit Scheme and Stock Appreciation Rights (SAR) are some major plans adopted and formulated by companies in India.
Procedure for putting in place a Company’s Employee Stock Option Plan
For an explicit understanding of the procedure and practical working of ESOP, let’s take an example into consideration.
TC Co.Ltd is a company that provides SAAS solutions. They wish to formulate and implement ESOP, the objective of implementing ESOP in the Company is to motivate employees, create a sense of belongingness amongst them, vest ownership in employees, reward performance, enhance retention and attract talent in the company. Rahul, the Asst. Chief Information Officer is one of the many beneficiaries of the Scheme proposed to be implemented by TC Co.Ltd.
TC Co.Ltd has decided to grant i.e. issue options for 10,000 shares to its employees on the 1st of September 2019. Of the total options granted an option of 1000 shares is given to Rahul. The Vesting Period is 3 years and the exercise period is 2 years. Exercise price shall be Rs. 100 per share. TC Co.Ltd has proposed to formulate and implement a time based ESOP i.e. the Option shall vest on the employees upon expiry of a certain time period.
It is pertinent to note that ESOS is not always time based it may also be performance based or even a combination of the two. Options may either be granted in lump sum as in the case of TC.Co Ltd or in parts.
In light of Rahul’s example let us understand how an employee can buy the shares granted to him under ESOP.
LEGAL COMPLIANCES FOR THE FORMULATION AND IMPLEMENTATION OF ESOP
In ensuring legal compliance required under the law, TC Co.Ltd is required to follow the following procedure while formulating and implementing ESOP;
- First and foremost the shareholders of TC Co.Ltd have to approve the issue of ESOP by passing a Special Resolution in the General Meeting.
- TC Co.Ltd have the freedom to determine the Exercise Price of the Options to be granted under ESOS, but are required to do so in accordance with the applicable accounting policies.
- If TC Co.Ltd wants to grant an option to employees of a subsidiary or holding company or if during one year, option granted to identified employees is equal to or exceeding 1% of the issued capital of the company, then under such circumstances the approval for such a grant shall be obtained from the Shareholders by a separate resolution.
- TC Co.Ltd may change the terms of ESOS which has not yet been exercised by the employees by a Special resolution, provided such changes shall not be detrimental to the interest of the Option holders.
- TC Co.Ltd has the freedom to decide the vesting period, but under no circumstances shall this period be less than 1 year.
Note: Even if a scheme provided by the company is a performance based scheme and the target is achieved before the expiry of the 1 year even then the option shall not vest on the employee, the option shall only vest upon the expiry of vesting period of 1 year.
- Rahul and other employees who have received options under the scheme do not have any right to dividend or voting in respect of options granted to them, until the shares are issued to them upon exercise of option by them.
- The option granted to Rahul is non-transferable and no one except rahul may exercise the option. Rahul cannot pledge, hypothecate, mortgage or encumber or alienate the option granted to him.
- If Rahul dies while in employment all options granted to him till such date shall vest in the legal heirs or nominees of Rahul . In case Rahul suffers permanent incapacity while in employment all options granted to him as on the date of total incapacitation shall vest on him on that day.
- If Rahul is either terminated or if he resigns then all options not vested in Rahul as on that date shall expire.
- If Rahul is transferred or deputed to an associate company of TC Co. Ltd before vesting or exercise, the vesting and exercise as per the terms of the grant shall continue even after the transfer or deputation.
- The Board of Directors of TC Co.Ltd, in their annual Directors Report shall disclose all details that are required to be disclosed under Sec. 12(9) of the Rules.
- TC Co.Ltd is required to maintain a Register of Employees Stock Option either at the registered office of the TC Co.Ltd or any other place that the Board decides. All entries made in the register shall be authenticated by the company secretary of TC.Co.Ltd or any other person authorised by the Board.
- Listed Companies are mandated to follow the guidelines and rules laid down by SEBI while issuing Employees Stock Options.