EMPLOYEE STOCK OPTIONS PLAN OR EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)

Meaning:

Employee Stock option plan or Employee Stock Ownership Plan (ESOP) is an employee benefit scheme that enables employees to own shares in the company. ESOP motivates the employee to be committed towards the company for a long term and also take ownership of the company making the employee more committed towards the Company.

Employee Stock Option Plans are one of the most important tools to attract, encourage and retain Employees. It is the mechanism by which employees are compensated with increasing equity interests over time.

Applicable provisions of ESOP:

• All companies other than listed companies should issue it in accordance with the provisions of the Companies Act, 2013 (hereinafter referred to as “the Act”) and Companies (Share Capital and Debentures) Rules, 2014 (hereinafter referred as to “the Rules”).
• In the case of listed companies, apart from the above act and rules, ESOS /ESPS should issue in accordance with Securities and  Exchange  Board  of  India  (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“hereinafter referred to as “Regulations”)

Definition of ESOS/ESPS:

As per Regulations2 (j), Employee stock option scheme or ESOS” means a scheme under which a company grants employee stock options to employees directly or through a trust

As per Regulation 2 (k), employee stock purchase scheme or ESPS” means a scheme under which a company offers shares to employees, as part of public issue or otherwise, or through a trust where the trust may undertake secondary acquisition for the purposes of the scheme

Section 2(37) of the Act 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 purchase or benefit or subscribe for the shares of the company at a predetermined price on a future date.

(Other relevant provisions as per the Act:

Section 62(1)(b) of the Act allows a company to issue further capital to the employees under a scheme of employees’ stock option provided a special resolution is passed and the conditions as prescribed are fulfilled.

Further, Section 62(1)(a) of the Companies Act, 2013 allows a company to issue further share capital by way of a rights issue to the existing shareholders. Section 62(1)(c) of the Act allows a company to issue share capital to people other than existing shareholders and employees provided that the price of the shares is determined by a valuation report and fulfilment of other prescribed conditions.)

Few Benefits of ESOP:

1. Acts as a source of motivation for the employees after making them shareholders of the company. Owning a stock makes them more responsible towards the company and they provide better performance for increasing the value of shares of the company.
2. It helps the Company in retaining the employees
3. preventing a significant amount of cash outflow from the company.
4. ESOP structures allows for multiple tax advantages

Types of ESOP

1. Employee Stock Purchase Plan (ESPP) – is a plan that allows employees to use their own money to buy company shares at a discount. It is issued by the company for its employees to encourage employee ownership in the company. The shares of the companies are given to the employees at discounted rates and the Company expects minimum service period from the employees
2. Employee Stock Option Scheme (ESOS)- An ESOP is a qualified defined contribution retirement plan, so employees don’t purchase shares with their own money. The employee is granted options on a pre-defined valuation, once the vesting period is over, the employee can exercise options to own shares, by paying the pre-defined exercise price.
3. Restricted Stock Units (RSU) – the employee is granted shares of the company only after the occurrence of an event. There is generally no vesting period or exercise price in RSU.
4. Stock Appreciation Rights (SARs) – In case of  SARs employee gets the benefit in the form of cash / equity which is the difference between the date of grant and final exercise of options. in this type, the company offers cash in exchange of the shares if a condition is met. But several companies use SARs as the ESOP model.

Rule 12 of the (Share Capital and Debentures) Rules, 2014

Under the said Rules, ESOPs can be issued only to the “employees” of an unlisted private limited company.

Rule 12(1) defines “Employee” as:

• A permanent employee of the company who is working in India or outside India
• A Director of the company, including a whole-time or part-time director but not an independent director
• A permanent employee or director of a subsidiary company in India or outside India, or holding company (whether a whole time director or not but excluding an independent director), but does not include-
• an employee who is a promoter or a person belonging to the promoter group; or
• a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company

(“Provided that in case of a startup company, as defined in notification number 3[G.S.R. 127(E), dated 19th February, 2019 issued by the Department for Promotion of industry and Internal Trade], Ministry of Commerce and Industry Government of India, Government of India, the conditions mentioned in sub-clause (i) and (ii) shall not apply upto 4[ten years] from the date of its incorporation or registration.”)

Glance at provisions under the relevant Act, Rules and Regulations for issue:

Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 (“Rules”) governs the issuance of ESOP for unlisted Companies. In case of listed companies, other than the Act and Rules, Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014, shall also be complied with.

A brief summary of such requirements listed under the Act, Rules and Regulations are as follows:

1. The ESOP scheme should be approved by the shareholders by way of a special resolution shall be obtained by the company in case of—

(a) Grant of option, SAR, shares or other benefits, as the case may be, to employees  of subsidiary or holding company;

(b)Grant  of  option,  SAR,  shares or  benefits,  as  the  case  may  be,  to  identified

employees, during any one year, equal to or exceeding one per cent. of the issued

capital  (excluding  outstanding  warrants  and  conversions)  of  the  company  at  the

time of grant of option, SAR, shares or incentive, as the case may be

2. The notice for such special resolution shall include an explanatory statement, which have the following:

(a) the total number of stock options to be granted;

(b) identification of classes of employees entitled to participate in the Employees Stock Option Scheme;

(c) the appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;

(d) the requirements of vesting and period of vesting;

(e) the maximum period within which the options shall be vested;

(f) the exercise price or the formula for arriving at the same;

(g) the exercise period and process of exercise;

(h) the Lock-in period, if any;

(i) the maximum number of options to be granted per employee and in aggregate;

(j) the method which the company shall use to value its options;

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

(l) 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

(m) a statement to the effect that the company shall comply with the applicable accounting standards

3. There should be a minimum period of 1 year between the grant of options and vesting of options.
4. The employees shall not have the right to receive dividend or to vote or enjoy the benefits of a shareholder in respect of the option granted to them, till shares are issued.
5. The options granted cannot be transferred by the employee or pledged, hypothecated, or mortgaged by the employee.
6. The Board of directors, shall, inter alia, disclose in the Directors’ Report for the year, the following details of the Employees Stock Option Scheme:

(a) options granted;

(b) options vested;

(c) options exercised;

(d) the total number of shares arising as a result of exercise of option;

(e) options lapsed;

(f) the exercise price;

(g) variation of terms of options;

(h) money realized by exercise of options;

(i) total number of options in force;

(j) employee wise details of options granted to;-

(i) key managerial personnel;

(ii) any other employee who receives a grant of options in any one year of option amounting to five percent or more of options granted during that year.

(iii) identified employees who were granted option, during any one year, equal to or exceeding one percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant;

7. The company shall maintain a Register of Employee Stock Options in Form No. SH.6and shall forthwith enter therein the particulars of option granted
8. Further, conditions for administration of specific schemes viz. employee stock option schemes, employee stock purchase schemes, stock appreciation rights scheme, general employee benefit scheme and retirement benefit schemes have been provided in the Regulations.
9. Regulations provide for the setting-up a compensation committee by the company which would determine the detailed terms and conditions of the schemes, including, eligibility of the employees

Disclaimer:  This Article is only a knowledge sharing initiative and is based on the Relevant Provisions as applicable and as per the information existing at the time of the preparation. In no event RMPS & Co. or the Author or any other persons be liable for any direct and indirect result from this Article or any inadvertent omission of the provisions, update etc if any.

Please follow and like us: