In the current trend of booming industry of startups,
competition has risen. Thus, in order to attract talents or to
retain current employees, more and more startups are exercising the
option of Employee Stock Options (used as ESOPs). Also, early stage
startups who lack capital infusion also use ESOPs as a tool to hire
employees on a lower payroll when compared to the industry
standards by giving them ESOP options.
§ 2(37) and § 62(1)(b) of the Companies Act, 2013
governs the issuing of the ESOPs by private companies. Startups can
opt the administration of ESOP by either its Board of Directors or
by creation of an ESOP Trust (per Indian Trusts Act). Startups
should opt for administration of ESOPs through the Board of
Directors, as forming a trust first is a more complex procedure and
in early seed startup with less number of employees, ESOPs through
a board of directors is a far simpler process.
EXERCISING ESOPS BY A STARTUP
Through Board of Directors Route-
A startup cannot just grant employee stock options by issuing a
simple letter. Often early-stage startups do this and then have to
eventually handle disgruntled employees because they suddenly wish
to exercise their options which, strictly under Indian law, were
never really granted to them. Certain measures need to be taken
before issuing ESOPs to the employees
Get an ESOP scheme drafted and approve it in a shareholders'
meeting. Till June 2015, this scheme had to be approved by a
'special resolution' and filed with the Registrar of
Companies (ROC). With effect from June 05, 2015, vide notification
G.S.R. 464(E), private limited companies do not have to comply with
Section 62(1)(b) of the Companies Act, 2013 which originally
mandated ESOP schemes to be approved through a 'special
resolution' and file its key terms with the ROC, making all
this information available publically. Once an ESOP scheme is
approved by the shareholder, a Letter of Grant must be issued to
the employee informing him how many options are being granted to
him and what the vesting period would be. Also, he should be
informed about exercise price will be determined, if he choose to
exercise the vested options. In the event an employee wishes to
exercise any of his vested options, he should make an Exercise
Application to his employer company pursuant to which his options
would be converted into equity.
UNDER THE TRUST ROUTE-
A Trust is formed under the Indian Trusts Act, and the Trust
Deed is registered with the jurisdictional Sub-Registrar. The ESOP
Trust receives stock either from company by way of fresh allotment
or by purchasing from existing shareholders in open market or the
owner of the company may sell shares of his holding to the ESOP
Trust. The ESOP Trust usually obtains its funds through a loan
either from a financial institution or from the seller or a
combination of institutions and seller. A company can extend loan
to the Trust for purchasing the Shares. There is a specific
provision in the Companies Act, which permits such loan under Sec.
77(2) (b) and (c). Then, the ESOP Trust allots shares to employees
on exercise of their right in exchange of cash and repays its
KEY POINTS TO BE CONSIDERED WHILE DRAFTING AN ESOP
Most employees have employment contracts that allow termination
upon giving some notice.
A startup would definitely not want an ex-employee to hold
equity in its venture when such employee could very well be working
for, say, a competitor. Accordingly, terms of an ESOP scheme have
to be carefully thought out and discussed. Proper exit mechanism
for employees and vesting options should be outlined in order to
fulfill the objective of retaining talent.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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