ESOP FAQs: Definition, Eligibility, Issuance

Posted On - 4 October, 2022 • By - Suma RV

ESOP or Employee Stock Option Plans

Frequently Asked Questions 

Question 1: What are ‘ESOPs’ And Why Are They Important? 

Employee Stock Option Plans (ESOPs) enable organizations to recognize and reward top performers who contribute to the success of their organization by awarding them an equity stake or a cash payment based on an equity investment. Employee stock options in India may or may not be included in total compensation packages. It serves as an effective tool for motivating recipients to make long-term commitments, making them a crucial component of a successful company’s growth story.  

The purpose of employee stock options is generally to retain the right talent, reward their performance and encourage employees to purchase stock in the sponsoring company. They are often offered at a predetermined price. This encourages employees to link their performance to shareholder interests. These shares will be held in trust until the employee exercises their options or retires from the company. Exercise of options will be at the discretion of the employee; and in case of resignation, unexercised options will get cancelled. 

Question 2: Who Is Eligible For A Grant Of ESOP?  

The Companies (Share Capital and Debentures) Rules, 2014 define an ‘employee’ as any individual who works permanently for a company, including directors (whether or not they are full-time directors and/or based in India). Under Rule 12(1), employee stock options may be granted to any permanent employee, any non-independent director, and any permanent employee or director of a subsidiary, affiliate, or holding company. However, a business cannot provide an ESOP to an employee if the employee is a member of the promoter group or one of the company’s promoters, or if the director in question directly or indirectly owns more than 10% of the company’s outstanding equity shares. That said, startups are exempt from this for ten years after their creation.  

Question 3: How Are ESOPs Issued?    

The issue of ESOPs is governed by Section 62(1)(b) of the Companies Act, 2013, and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. The listed companies should also adhere to relevant guidelines issued by the Securities and Exchange Board of India. The process is as follows for an unlisted company, provided that the Articles of Association of the company authorized for issuance of shares through ESOP:   

  • Step 1: Draft ESOP Scheme And Notice 
    The ESOP Scheme draft and a notice for a board meeting are drafted under the Companies Act, 2013, and Companies Rules, 2014 along with a draft resolution for the meeting.  
     
  • Step 2: Notifying The Board Members  
    The notice should be sent to all the directors seven days before the board meeting.  
     
  • Step 3: Passing The Draft Resolution  
    It is required to authorize the holding of the meeting to adopt a special resolution for issuing ESOPs. This should be followed by the passing of the resolution for the issuance of shares via ESOP, and lastly, deciding the price of shares to be issued via ESOPs, and setting the meeting date and time for passing a special resolution.  
     
  • Step 4: Filing of Draft Minutes & MGT-14 Form  
    The draft minutes of the abovementioned board meeting must then be forwarded to the directors within 15 days, and MGT-14 must be filed with the Registrar of Companies within 30 days of the resolution being passed.  
     
  • Step 5: General Meeting Notice  
    The general meeting must be announced at least twenty-one days in advance to all of the company’s directors, auditors, shareholders, and secretarial auditors.  
     
  • Step 6: Passing The Special Resolution And Filing The MGT-14 Form  
    The special resolution for the issue of shares under the ESOPs to the company’s employees, directors, and officers must be passed in the general meeting. The MGT-14 form, along with the documentation, is then filed with the Registrar of Companies within thirty days of the special resolution being passed in the general meeting.  
     
  • Step 7: Sending Options And Maintaining A Register  
    Employees, directors, and executives of the company receive ESOPs to purchase shares under the plan. A Register of Employee Stock Options in Form No SH-6 must be kept, and details of the Employee Stock Option Plan awarded to the company’s employees, directors, or officers must be entered.  

Question 4: What Allotment And Disclosures Should Be Made? 

To allot the Employee Stock Options, there are three stages. They are:   

  • Grant: It refers to the distribution of stock to employees. It entails informing the employee that they are qualified for an ESOP. While offering the Employee Stock Option to employees, the company will be allowed to set the exercise price.  
     
  • Vest: It refers to the issuance of stock to employees. It entails informing the employee that they are qualified for an ESOP. The corporation will be allowed to set the exercise price while offering employees the option of an ESOP.  
     
  • Exercise: Employees have the option to purchase the shares. The corporation will be free to choose the lock-in period for the shares issued after the option is exercised. Employees will not be able to collect dividends, vote, or enjoy the benefits of a shareholder under the ESOPs granted to them until the shares are issued upon exercise of their option.  

Furthermore, before the aforementioned special resolution is passed, the specifics of the approach must be disclosed. The specifics should be disclosed in the form of an explanatory statement, which must include information such as: 

  • The total number of ESOPs to be granted.  
  • The eligibility assessment process.  
  • The vesting requirements and period. 
  • The exercise price and pricing formula. 
  • The exercise period. 
  • The method of accounting. 
  • The lock-in period. 
  • The circumstances under which vested options may lapse, and so on.  

Question 5: Do employees pay for ESOP?   

Employees often pay a modest price to purchase the shares allotted to them while exercising their ESOPs. As a result, they can invest in the company at a discounted rate.  

Question 6: What Are ESOPs From An Employer’s Perspective? 

Employers generally use employee stock ownership plans in India as a recruitment and retention strategy for top performers. Stocks are frequently distributed in stages by corporations. Companies aim to retain long-term employees while also converting them into shareholders. In India, cash received through employee stock option programs may be used to purchase company shares and existing shareholder shares. Contributions to an ESOP are tax-deductible if utilized to repay the outstanding loan. Both principal and interest are tax-deductible. Furthermore, private company shareholders can sell their shares through the ESOP. Companies can purchase their shares from money received from the ESOPs or make tax-deductible donations to the Employee Stock Option Plan. 

Question 7: What happens to ESOPs when the employee retires?   

An employee does not pay taxes on their shares while held by Employee Stock Option Plan. If they quit the company or retire, they can sell their stock on the open market or sell it back to the company.  

Question 8: Can the ESOP scheme also include future employees?   

Yes, the ESOPs scheme can also include future employees. 

Endnotes 

Companies today commonly use ESOPs to maintain and improve employee performance, benefiting both employers and employees. Employee Stock Option Plan are especially beneficial for startups that are unable to pay their employees as competitively as larger firms. Giving employees a part in the company helps these startups recruit talent. They are undeniably beneficial to both businesses and employees. Motivated employees contribute more successfully to the company’s goals.

They align their goals with the goals of the organization. On the other hand, the company’s success is dependent on the quality of its employees’ labour. The distribution of Employee Stock Option Plan to all employees by companies in India has expanded awareness of the benefits of such plans and has begun to significantly contribute to the differentiation of companies that reward employees who are willing to align themselves with the company’s long-term goals.