ESOP

Overview

Our objective is to assist companies in utilizing ESOPs as a strategic tool for attracting, retaining, and incentivizing top talent. Our range of services encompasses consultation on ESOP policies, formulation of ESOP schemes, and ongoing support to ensure alignment with your company’s objectives and regulatory requirements. With Trademarkwala, your business can harness ESOPs to cultivate a culture of ownership and enhance employee engagement.

What Is an ESOP or the Employee Stock Option Plan?

An Employee Stock Option Plan (ESOP) is a benefit scheme offering employees the opportunity to purchase company shares at a predetermined price. It serves as a mechanism for companies to attract, retain, and reward employees while aligning their interests with the company’s growth and success.

Benefits of Employee Stock Option Plan

ESOPs motivate staff as their benefits grow with the company’s market share price.
They contribute to reducing employee turnover by incentivizing retention.
Employees are rewarded for their contributions, particularly during challenging periods.
ESOPs facilitate the preservation of company cash reserves by minimizing major cash outflows.

Advantages and Disadvantages of an Employee Stock Option Plan

Advantages of ESOP

Motivation and Retention: ESOPs foster employee motivation and retention by instilling a sense of ownership.
Tax Benefits: ESOPs offer specific tax advantages to both employers and employees.
Cash Flow: They enable companies to conserve cash by providing non-cash compensation.

Disadvantages of ESOP

Dilution of Ownership: ESOPs may result in dilution of ownership and control as employees acquire shares.
Fluctuating Market Risk: The value of ESOPs is subject to fluctuations in the company’s stock price, which can be volatile.
Administrative Costs: Implementing and managing ESOPs entail certain administrative complexities and costs.

How Does an Employee Stock Option Plan Work?

Let’s explore the functioning of an ESOP based on the following explanation: When a company initiates ESOPs, they are held in trust for a specific duration, known as the vesting term. Following this period, employees gain the right to exercise their ESOPs. The allocation of shares, their pricing, and the eligible recipients are determined beforehand. Subsequently, selected employees can exercise their ESOPs by purchasing company shares at predetermined prices, often below market value.

Cost of ESOPs and Distributions

The expenses associated with ESOPs can vary depending on the specific plan. However, there are certain common costs that employers might encounter, including:

Setting up and administering the plan
Purchasing shares for employees
Providing loans to employees for purchasing shares
Tax implications

Checklist for Employee Stock Option Plan 2023-2024

To ensure compliance and smooth implementation of the Employee Stock Option Plan for the period 2023-2024, consider the following checklist:

Review articles for provisions regarding share issuance under the employee stock option scheme.
Include the date and members of the compensation committee in the board meeting records.
Provide notice of the general meeting, specifying the number of ESOPs to be granted.
Conduct a general meeting for shareholder approval via ordinary resolution, authorizing the issuance of ESOP shares and the formation of the compensation committee.
Establish a compensation committee comprising a majority of independent directors.
Obtain approval from shareholders through a separate resolution.
Prepare draft copies of certificates.
File Form-PAS-3 as required.
Disclose ESOP details in the Director’s Report.
Maintain the register of ESOPs in SH-6 at the company’s registered office or as determined by the board.
Ensure entries in the register are authenticated by the Company Secretary or another authorized individual.

Eligibility for Employee Stock Option Plan

As per IRS (Indian Revenue Service) guidelines, eligibility for an ESOP includes:

A maximum age limit set by the employer, not exceeding 21 years.
Eligibility for ESOP upon joining the company.
Possible restriction on eligibility to employees with at least two years of service, provided the plan offers immediate vesting.

How to Register an Employee Stock Option Plan

Draft the ESOP Rules: Define the terms governing all options granted under the plan, including granting processes, exercise procedures, and options treatment upon exit or employee departure. The rules should include:
- Schedule 1: Grant letter outlining option terms for recipients.
- Schedule 2: Exercise notice form for option holders.
- Schedule 3: Option certificate recording option details.
Approve the Rules and Option Pool: After finalizing ESOP rules, obtain corporate approval through director and shareholder signatures to adopt the rules and establish the option pool.
Board and Shareholder Approval: Pass resolutions for:
- Approval of ESOP rules.
- Determination of the total options in the ESOP pool.
- Authorization for the board to grant options and issue shares.
Shareholder Waivers and Consents: Obtain waivers from shareholders with preemptive rights concerning options granted through the ESOP, as per the constitution and shareholder agreements.

Granting Options

Prepare Your Directors’ Resolutions: For each instance of granting options, request your corporate secretary to draft new directors’ resolutions in writing, officially approving the issuance of options to specific recipients.

Send Each Recipient Their Grant Letter: Upon receipt of the resolution, provide each recipient with their grant letter. Issue an individual option certificate using the format outlined in Schedule 3. Ensure the schedule remains blank, and create a separate Word document for each recipient.

Update Your Option Register: Maintain an internal option register, detailing all options granted by the company, including vesting schedules, expiry dates, and exercise dates.

Documents for Employee Stock Option Plan

Minutes of board meetings.
Special resolution approving the ESOP, accompanied by an explanatory statement.
Minutes of general meetings.
Board reports.
Register of employee stock option plans.
Forms PAS-3 and MGT-14.

Tax Implications of ESOPs and ESOP Calculation

ESOPs (Employee Stock Option Plans) provide employees with the opportunity to purchase company stock at a discounted price, with the following tax implications:

Tax on Exercise: Employees are liable to pay tax on the difference between the exercise price and the fair market value of shares at the time of exercise, treated as part of their salary income.
Capital Gains Tax: Upon selling ESOP shares, capital gains tax applies, dependent on the holding period.
Dividend Tax: Dividends paid on ESOP shares are subject to applicable tax rates.

Benefits of ESOPs for Employees

ESOPs serve as a motivational tool for employees, offering several advantages such as:

Financial Incentives: Employees can purchase company stock at a discounted price, providing significant financial motivation.
Ownership Stake: ESOPs grant employees a stake in the company’s success, fostering job satisfaction and motivation.
Tax Benefits: ESOPs may offer tax advantages, including lower capital gains tax rates for long-term holdings.
Diversification: Selling ESOP shares allows employees to diversify their investment portfolios and mitigate risk.
Retirement Benefits: ESOPs can serve as a valuable source of retirement savings, particularly if the company’s stock performs well over time.

ESOPs to Employers

Employee Stock Ownership Plans (ESOPs) offer numerous benefits to employers, including:

Increased employee engagement and productivity: ESOPs can boost employee engagement and productivity by providing employees with a vested interest in the company’s success. Ownership of company stock motivates employees to strive for excellence and contribute towards organizational goals.
Reduced employee turnover: ESOPs contribute to lower employee turnover rates by fostering a sense of loyalty and commitment among employees. Ownership of company shares encourages employees to stay with the organization for the long term, as they feel valued and connected to its success.
Improved financial performance: Studies indicate that companies with ESOPs generally outperform those without. This is attributed to the motivational impact of ESOPs on employees, resulting in enhanced performance and reduced turnover, ultimately leading to improved financial results.
Tax benefits: Employers can benefit from various tax advantages associated with ESOPs, including deductions for contributions to the plan and deferral of capital gains taxes on shares sold to the ESOP.

ESOPs to Employees

Employee Stock Ownership Plans (ESOPs) offer several advantages to employees, including:

Ownership in the company: ESOPs provide employees with a sense of ownership and stake in the company’s success. This ownership fosters a stronger commitment to the organization’s goals and encourages employees to take pride in their work.
Potential for wealth creation: ESOPs enable employees to accumulate wealth over time as the value of company stock increases. Employees can realize profits by selling their ESOP shares or holding them until retirement, when they receive distributions from the ESOP.
Retirement savings: ESOPs serve as a valuable tool for retirement savings, as ESOP shares are typically held in tax-advantaged retirement accounts. Employees can grow their retirement funds without immediate tax implications, enhancing their financial security in retirement.
Job security: ESOPs promote job security by incentivizing long-term employment. These plans often prioritize benefits for employees with extended tenure, encouraging loyalty and dedication to the company’s long-term success.

Procedure for Issue of Employee Stock Option Plan

The issuance of Employee Stock Option Plan (ESOP) follows a structured procedure:

Authorization in Articles of Association (AOA): The AOA should include provisions authorizing the issuance of ESOP shares. If absent, an extraordinary general meeting must be convened to amend the AOA accordingly.
Preparation of ESOP Draft: Draft an ESOP scheme in compliance with the Companies Act of 2013.
Board Meeting: Present the draft resolution at a board meeting for approval by all directors and shareholders.
Shareholder Approval: Obtain acceptance of the ESOP scheme from all shareholders and directors for further resolution.
General Meeting: Discuss the share price, issuance details, and schedule a special resolution for ESOP issuance.
Filing of MGT-14: File Form MGT-14 with the Registrar of Companies (RoC) following the board resolution. Share the draft minutes with all directors within 15 days of the meeting.
Special Resolution: Pass a special resolution in a general meeting to issue shares under the ESOP scheme to employees, directors, and officers. File MGT-14 with the RoC within 30 days of passing the resolution.
Creation of Register: Establish and maintain a register of employee stock options in Form SH-6, recording all ESOP particulars granted to employees.

Why Companies Offer ESOPs to Their Employees?

Companies offer ESOPs to their employees for various reasons, including:

Attracting and retaining top talent: ESOPs serve as an attractive benefit package, aiding in the recruitment and retention of skilled employees.
Motivating employees and improving productivity: Ownership of company shares through ESOPs motivates employees to perform better, leading to increased productivity and overall organizational success.
Rewarding employees for contributions: ESOPs provide a tangible way to reward employees for their dedication and contributions to the company’s growth and success.
Aligning interests: By giving employees a stake in the company’s performance, ESOPs align the interests of employees with those of the company, fostering a sense of shared purpose and commitment to achieving corporate goals.

ESOPs from an Employee's Perspective

From an employee’s perspective, ESOPs offer significant benefits:

Ownership and pride: ESOPs allow employees to own shares in the company they work for, instilling a sense of ownership and pride in their work.
Retirement savings and wealth building: ESOPs provide employees with an opportunity to save for retirement and build wealth over time through ownership of company stock.

ESOP Taxation

Understanding the tax implications of ESOPs is crucial for employees:

Deferral of taxes on purchase price: Employees may have the option to defer taxes on the purchase price of shares acquired through an ESOP.
Capital gains taxes on share sales: Employees may be subject to capital gains taxes when selling shares acquired through an ESOP.
Income taxes on distributions: Distributions received from an ESOP may be taxable as income for employees.

While ESOPs offer valuable benefits, navigating their tax implications requires careful consideration and planning.

What Happens to ESOPs When the Company Is Listed?

When a company becomes listed on a stock exchange, the ESOP shares can be traded on the open market. This offers employees the opportunity to sell their shares and realize their investment gains.

To Whom Can ESOPs Be Issued?

The issuance of ESOPs in India is regulated by various laws, including the Companies Act, 2013, and the Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014.

ESOPs can be issued to all permanent employees of the company, both domestic and international. Additionally, directors of the company (excluding independent directors) are eligible to receive ESOPs.
Employees of subsidiary or holding companies may also receive ESOPs, provided they meet the eligibility criteria outlined in the ESOP scheme.
Members of the promoter group who are not promoters themselves may receive ESOPs.
ESOPs cannot be issued to non-employees like consultants or contractors. However, equity shares can be issued to non-employees subject to specific conditions.

Process and Allotment of ESOPs

The process and allotment of ESOPs in India follow these steps:

Grant of ESOPs: ESOP agreements specify the number of shares, exercise price, and vesting period for eligible employees.
Exercise of ESOPs: Employees can exercise their ESOPs after the vesting period. The exercise price is determined by the ESOP agreement, and the company must ensure there are sufficient liquid shares available for the scheme.
Allotment of Shares: Upon exercise, the company allots shares to employees within 15 days.
Transfer of Shares: Shares must be transferred to employees’ Demat accounts within two days of allotment, with notification to the stock exchange.
Payment for Shares: Employees must pay the exercise price within six months of share allotment.
Compliance: The company must adhere to all relevant regulations during the issuance and allotment of ESOPs.
Reporting Requirements: The company must fulfill reporting obligations as per SEBI regulations, including disclosures to the stock exchange and filing necessary reports with SEBI.

Recent Updates

Unacademy to Buy Back Employee Stock Option Plans (ESOP)

On October 16, 2020, Ed-Tech Start-up Unacademy announced its intention to repurchase ESOPs from 145 employees by the end of 2020.
Unacademy plans to spend an estimated 30 crores for the buyback of ESOPs from current and former employees following its attainment of ‘unicorn’ status in September.

Increase in Oyo’s ESOP Balance

On September 28, 2020, Oyo reported a significant increase in its Employee Stock Option (ESOP) balance by Rs. 1054 crores.
This surge reflects the growing emphasis on ESOPs within the startup ecosystem, with organizations expanding their ESOP pools to benefit their employees.
Oyo added 2700 shares to its existing ESOP, demonstrating its commitment to employee welfare and incentivization.

Why Trademarkwala?

Trademarkwala facilitates a seamless experience throughout the ESOP process, offering:

Assessment of Owner Agreement: Determine the willingness of other owners to participate in ESOPs.
Feasibility Study: Conduct a thorough analysis to ascertain the viability of implementing ESOPs.
Valuation Services: Undertake valuation exercises to determine fair share prices.
Legal Guidance: Engage experienced ESOP attorneys for legal counsel and support.
Funding Assistance: Assist in securing funding required for implementing the ESOP plan.
Operational Setup: Establish efficient processes for the operation of the ESOP plan.

For streamlined ESOP procedures, opting for a proficient legal advisory firm is crucial, and Trademarkwala is the solution!