Employee stock option plans (ESOPs) are being widely used by
both public companies and startups as a means of monetary
compensation and to provide incentives for employees. While
startups use employee stock options in order to attract talent on
account of not being able to afford high salaries and to manage
direct cost, publicly traded companies use such plans as a
retention tool. The wealth creating potential of ESOPs has been
highlighted by reports about how they have created millionaires of
employees at Infosys and the likes of Flipkart.
Globally, companies adopt one or more of the following types of
plans, depending on their business requirements and objectives: (a)
employee stock option scheme (ESOS); (b) employee stock purchase
plan; (c) restricted stock units; (d) stock appreciation rights;
and (e) phantom stocks. In India, the most commonly used ESOP
vehicle by private companies is the ESOS. Also, ESOP structuring
can be done by setting up a trust based on commercial and tax
Statutory compliance: It is mandatory for every
private company and public unlisted company that proposes to issue
employee stock options to employees to have in place an ESOP scheme
that is in consonance with section 62(b) of the Companies Act,
2013, read with rule 12 of the Companies (Share Capital and
Debentures) Regulations, 2014 (ESOP Regulations). Prior to the ESOP
Regulations, there was no legislation regulating issuance of ESOPs
by private companies. Public listed companies, however, have been
governed by the Securities and Exchange Board of India (Share Based
Employee Benefits) Regulations, 2014.
Who is an eligible employee: The ESOP
Regulations permit issuance of ESOPs to: (i) permanent employees
who have been working in India or outside India; (ii) directors;
and (iii) employees of subsidiaries, associate companies and
holding companies. However, a director (directly or indirectly
holding more than 10% of equity shares), an employee who is a
"promoter" and consultants are excluded from definition
of an employee to whom employee stock options can issued.
There has been a major concern around exclusion of promoters
from the definition of employees under the ESOP Regulations, which
has led to structuring promoter compensation by way of issuance of
sweat equity, convertible preference shares, equity shares with
lock-in provisions, etc. The startup community and the report of
Companies Law Committee led by Tapan Ray have raised this issue,
which is expected to be addressed in this budget session.
The Foreign Exchange Management (Transfer or Issue of any
Foreign Security) Regulations, 2004, permit resident employees of
foreign subsidiaries in India or Indian companies (in which a
foreign corporation directly or indirectly holds equity) to acquire
options from its foreign holding company, provided the options are
issued under a cashless ESOS (without any remittance from India)
and that the shares under the scheme are offered globally on a
Vesting schedule: The ESOP Regulations
stipulate a minimum lock-in period of one year between grant of
options and vesting. However, as a general practice most companies
adopt a vesting period over four years, where options vest
proportionately or otherwise over each year. Typically, vested
options become exercisable on the occurrence of a liquidity
Exercise price: Vested options can be exercised
at an exercise price which is usually at par for startup companies
and at a discount to fair market value for slightly more mature
companies. ESOP vehicles usually also stipulate the exercise
period, i.e. the period during which the vested options can be
Transfer restriction: ESOPs usually impose
transfer restrictions in line with the charter documents of
companies on the shares that are issued upon the exercise of
options. In certain cases, companies prefer to keep control over
the vested shares. In such situations various mechanisms or
structures can be devised to address this concern.
Startups and public listed companies consider ESOPs as a major
incentive to motivate key employees, retain intellectual capital,
attract new talent and create wealth for employees. Accordingly, it
is important to structure an ESOP vehicle taking into account the
commercial and tax implications on the company.
The startup community as well the Companies Law Committee led by
Tapan Ray in its report pressed for relaxations of the ESOP
Regulations and ESOP taxation so as to allow flexibility in
structuring of ESOPs and simplify the ESOP issuance process. It is
hoped that the budget session will be productive in addressing
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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