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Best Practices of ESOP agreement- India

May 13, 2022
corporate

By Rupin Chopra and Apalka Bareja

Most of company’s policies are drafted with an aim to build a strong consumer market and to diversify and expand its business in order to satisfy the growing concerns and needs of the consumers. However, the companies are also increasingly accepting the importance of retaining the force behind their boosting revenues. Recruiting and training employees is a very taxing and onerous task and companies face great difficulty when they are unable to retain their talent.

To build strong long term relationships with employees it is necessary to keep them happy and make them feel a part of the organization they are working for and what better way than to give them a stake in the ownership of the company through Employee Stock Option Plan (ESOP)

What is ESOP?

Through ESOP, the employees are given a right to acquire shares of the company for which they are working.

Section 2(37) of the Companies Act, 2013 defines employees stock option as the option given to the directors, employees or officers of the company or of its holding or subsidiary company, the right to subscribe for the shares of the company at a predetermined price on a future date.

What are the applicable laws for issuing ESOP by an unlisted company?

  • The Companies Act, 2013[1]
  • Companies (Share Capital and Debentures) Rules, 2014[2]

Important terms related to ESOP

  • Grant of option

It is the process by which the Company issues options to employees under ESOP.

  • Vesting

It is the process by which employees become entitled to receive the shares of the company under ESOP.

  • Vesting period

It means the period after which employees can exercise the option granted to them under ESOP.

  • Exercise

It is the process of acquiring shares of the company by employees in exchange of option granted to them.

  • Exercise period

It is the time period after vesting period within which employees should exercise his right to apply for shares against the vested option.

  • Exercise price

It is the price payable by employees for exercising the option, if any.

To whom ESOP can be issued?

Rule 12(1) of Companies (Share Capital and Debentures) Rules, 2014 states that ESOP can be issued to the following employees-

  1. a permanent employee of the company who has been working in India or outside India; or
  2. a director of the company including a whole time director or  but not an independent director; or
  3. a permanent employee or a director of a subsidiary company in India or outside India or of a holding company.

but does not include

  1. an employee who is a promoter or a person belonging to the promoter group; or
  2. a director who either himself or through his relative or through anybody corporate holds more than ten per cent of the outstanding equity shares of the company, whether directly or indirectly

However, the above two conditions are not applicable to Startup Companies for a period of ten years from the date of its incorporation.

Disclosures to be made while issuing ESOP

Section 62(1)(b) of the Companies Act, 2013  and Rule 12(1) of Companies (Share Capital and Debentures) Rules, 2014  lays down that for issue of shares to employees under a scheme of employees‘ stock option, a special resolution is to be  passed by company.

The company needs to make the following disclosures in the explanatory statement annexed to the notice for passing of the special resolution for issuance of ESOP –

    1. 1. the total number of stock options to be granted;

 

    1. 2. identification of classes of employees who can participate in ESOP

 

    1. 3. the process for determining the eligibility of employees to participate in ESOP

 

    1. 4. the requirements of vesting and period of vesting;

 

    1. 5. the maximum period within which the options shall be vested;

 

    1. 6. the exercise price or the formula for arriving at the same;

 

    1. 7. the exercise period and process of exercise;

 

    1. 8. the Lock-in period, if any ;

 

    1. 9. the maximum number of options to be granted per employee and in aggregate;

 

    1. 10. the method which the company shall use to value its options;

 

    1. 11. the conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct;

 

    1. 12. the specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee; and

 

    13. a statement that the company shall comply with the applicable accounting standards.

When is a separate resolution required for issuance of ESOP?

  1. grant of option to employees of subsidiary or holding company; or
  2. grant of option to identified employees, during one year, equal to or exceeding one percent of the issued capital of the company at the time of grant of option.

Exercise price

The companies ESOP will have the freedom to determine the exercise price in conformity with the applicable accounting policies

Lock in period

The company enjoys the freedom to specify the lock-in period for the shares issued pursuant to exercise of option. However, there must be a minimum period of one year between the grant of options and vesting of option.

In case of amalgamation and mergers, where ESOP is granted in lieu of options held by the same person in another company, the period for which such shares were held by him in previous shall be adjusted in the lock in period.

Amount payable by employees at the time of grant of option

The amount, if any, payable by the employees, at the time of grant of option-

    1. 1. may be forfeited by the company if the option is not exercised by the employees within the exercise period; or

 

    2. the amount may be refunded to the employees if the options are not vested due to non-fulfilment of conditions relating to vesting of option as per the Employees Stock Option Scheme.

Disclosure to be made in the Directors’ Report       

The Board of directors shall disclose the following details of the Employees Stock Option Scheme in the Directors’ Report for the year:

    1. 1. options granted;

 

    1. 2. options vested;

 

    1. 3. options exercised;

 

    1. 4. the total number of shares arising as a result of exercise of option;

 

    1. 5. options lapsed;

 

    1. 6. the exercise price;

 

    1. 7. variation of terms of options;

 

    1. 8. money realized by exercise of options;

 

    1. 9. total number of options in force;

 

    10. employee wise details to whom options are granted

Register of Employee Stock Options

The company needs to maintain a Register of Employee Stock Options at the registered office of the company or such other place as the Board may decide. The entries in the register shall be authenticated by the company secretary of the company or by any other person authorized by the Board for the purpose

Conclusion

ESOP is especially beneficial for startups who cannot compensate their workers as competitively as established companies. Such startups attract employees by giving them a stake in the company. ESOP is definitely a win-win for both companies and employees. Employees feel motivated and work more efficiently towards the company’s goals. They align their interests with that of the company. Company, on the other hand, thrive on the high quality results of the employees.

 

[1] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf

[2] https://www.mca.gov.in/Ministry/pdf/NCARules_Chapter4.pdf

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