Employees are the most essential factor who are responsible for success of a business. To retain the best professionals has become cumbersome for companies & specially startups due to many reasons including cash crunch. One of the best ways to retain the best employees is to offer Employees' Stock Option. Large size companies also offer ESOP on a regular basis to the employees to make them believe that their personal growth is connected to the growth of the organisation. Under ESOP scheme, the company provides an option to the employees to exercise the specified number of shares for a discounted price without any obligation. There are other alternatives of ESOP such as “Stock Appreciation Rights” and “Restricted Stock Awards”.

Employees' Stock Option or ESOP

Section 2 (37) of Companies Act, 2013 defines ESOP as the option given to the Directors, Officers or Employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price;

Advantages of Employees' Stock Option

1. To attract the new talent and retain the existing employees by giving a sense of ownership;
2. To motivate employees to work better and participate actively in the success of the company;
3. To control costs and minimize the risk by substituting the cash with ESOP.

For the purpose of ESOP Employee means:

1. a permanent employee of the company who has been working in India or outside India; or

1. a director of the company, whether a whole-time director or not but excluding an Independent Director; or

1. an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company

but does not include-

1. an employee who is a promoter or a person belonging to the promoter group; or

1. a director who either himself or through his relative or through anybody corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

Key Terms used in ESOP:

Grant: Issuance of option to apply for shares at a later date to the employee under ESOP scheme.

Option: The right but not an obligation granted to the Employees under the ESOP scheme to apply for shares under specified conditions.

Vesting: The process by which the employee gains the full right to the options of ESOP plan.

Vesting period: The tenure between the grant and exercising the ESOP which qualifies an employee for ESOP.

Exercise: The process of applying for Shares under ESOP plan upon payment of exercise price.

Exercise Price: The pre-determined price to be paid by the employee at the time of application for shares under ESOP.

ESOP Pricing

The companies granting option to its employees pursuant to ESOP will have the freedom to determine the exercise price in conformity with the applicable accounting policies, if any.

Modes of ESOP

There are 2 modes of ESOP, Direct Route or Trust Route. Most of the times, ESOP is issued through Direct Route because of less compliances.

Direct Route

Preferred by unlisted companies, in Direct route the company grants the option and defines the vesting period. After completion of vesting period, fresh Equity shares are issued at a pre-determined price to the eligible employees & becomes the shareholder of the company. Major concern in Direct Route occurs when the employee intends to monetize the shares, company may have to buy-back or wait for the company to for public offer.

Procedure of issuance of ESOPs (through Direct Route by unlisted Company):

Procedure of ESOP is different for both listed and unlisted companies. Let’s have a quick look at the procedures to be followed by an unlisted company:

1. Check AOA & MOA and if they don’t allow for ESOP, alter wherever necessary;

1. Draft the ESOP plan keeping in mind different level of management and the employees;

1. Call and convene a proper Board Meeting: (7 days prior notice)

1. To Authorize issue of shares under ESOP and the draft scheme of ESOP
2. To call General Meeting for approval of shareholder through Special Resolution
3. To issue notice of General Meeting

1. Notice of General Meeting to the Shareholders (21 clear days’ notice)

Disclosures in the Explanatory Statement annexed to the notice for passing of the resolution:

1. The total number of stock options to be granted
2. identification of classes of employees entitled to participate in the Employees Stock Option Scheme;
3. the appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;
4. the requirements of vesting and period of vesting;
5. the maximum period within which the options shall be vested;
6. the exercise price or the formula for arriving at the same;
7. the exercise period and process of exercise;
8. the lock-in period, if any;
9. the maximum number of options to be granted per employee and in aggregate;
10. the method which the company shall use to value its options;
11. the conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct;
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 a statement to the effect that the company shall comply with the applicable accounting standards.
13. a statement to the effect that the company shall comply with the applicable accounting standards.

1. Convene General Meeting and pass Special Resolution

• To Approve Employee Stock Option Plan Scheme;
• To Approve Allocation and Grant of Stock Options to Employees

1. Separate resolution by Shareholders is required for: -

1. grant of option to employees of Subsidiary or Holding company

1. grant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.

1. Convene Board Meeting for allotment of Shares and issuance of Share Certificates

1. Filing Form PAS-3 with Registrar of companies within 30 days of allotment.

1. Stamping of shares for the shares issued.

EMPLOYEE STOCK OPTIONS REGISTER

1. The company shall maintain a Register of Employee Stock Options in Form No. SH.6 and shall forthwith enter therein the particulars of option granted under clause (b) of sub-section (1) of section 62.
2. The Register of Employee Stock Options shall be maintained at the registered office of the company or such other place as the Board may decide.
3. 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.

DISCLOSURES TO BE MADE IN DIRECTOR REPORT:

1. options granted;
2. options vested;
3. options exercised;
4. the total number of shares arising as a result of exercise of option;
5. options lapsed;
6. the exercise price;
7. variation of terms of options
8. money realized by exercise of options
9. total number of options in force
10. employee wise details of options granted to:-

1. key managerial personnel

1. 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.

1. 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;

VARIATION IN TERMS OF ESOP

1. The company may by special resolution, vary the terms of Employees Stock Option Scheme not yet exercised by the employees provided such variation is not prejudicial to the interests of the option holders.

1. The notice for passing special resolution for variation of terms of Employees Stock Option Scheme shall disclose full of the variation, the rationale therefor, and the details of the employees who are beneficiaries of such variation.

MINIMUM VESTING PERIOD

1. There shall be a minimum period of one year between the grant of options and vesting of option.

Provided that in a case where options are granted by a company under its Employees Stock Option Scheme in lieu of options held by the same person under an Employees Stock Option Scheme in another company, which has merged or amalgamated with the first mentioned company, the period during which the options granted by the merging or amalgamating company were held by him shall be adjusted against the minimum vesting period required under this clause;

1. The company shall have the freedom to specify the lock-in period for the shares issued pursuant to exercise of option.

1. The Employees shall not have right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of option granted to them, till shares are issued on exercise of option.

TRANSFERABILITY OF ESOP

1. The option granted to employees shall not be transferable to any other person.

1. The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

1. Subject to clause (d), no person other than the employees to whom the option is granted shall be entitled to exercise the option.

1. In the event of the death of employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

1. In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.

1. In the event of resignation or termination of employment, all options not vested in the employee as on that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the Board.