ESOPs or Employee Stock Option Plans are the Employee Stock Option Plans or ESOPs are the most imperative type of compensation for employees. From a startup's point of view, it keeps up liquidity and from a employee's viewpoint, it is a reward for faithfulness.
The Current Blog talks about procedure, law behind the ESOPs as well as the key areas that need to be considered from Employer as well as Employee perspective. Let’s discuss:
Basically, an ESOP policy gives your team the right to purchase a specific number of shares in an organization at a fixed exercise price. The Companies (Share Capital and Debenture) Rules, 2014 ('Company Rules') govern this. Before plunging any further, let us to whom these ESOPs can be granted or we can say applicability as well.
According to Company Rules, just
- A permanent employee working in or outside India.
- A whole-time or part-time director of company, and
- An employee of a subsidiary (whether in India or abroad), holding company or an associate company,
can claim benefits under an ESOP scheme. It is absolutely important to note that neither a ‘promoter’, nor a director holding more than 10 per cent of the equity shares of the company is entitled to take part in this scheme.
How do ESOPs function?
Startup's point of view:
An organization can't simply give options by issuing a basic letter to its employees. Normally few early-stage-start-ups do this and then they have serious employees dissatisfaction at the end as and when employees wishes to exercise their options which are never legally granted to them. So practically they don’t have any right to exercise their option to purchase the shares in question.
From a startup's point of view, they need to do the following tasks:
- Get an ESOP Policy drafted & approve in the Shareholders meeting.
- Issue a Letter of Grant to all the employees concerned.
- At the time of exercise, Employee request through Exercise application.
- Company allots shares to the Employees.
Key focus areas:
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Employer’s Perspective |
Employee’s Perspective |
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Most employees have employment contracts that allow termination upon giving some notice. How will a start-up want to tackle a situation where some options have vested upon an employee but now he wishes to quit? |
Employee should always understand the detailed insights & terms & conditions for ESOP policy by getting a copy of that. |
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What happens if he is willing to work but the start-up wants to terminate the employee’s employment for ‘cause’ or even otherwise by simply giving the notice period? |
Is there any cliff period involved? This is the period after which actually vesting period start counting. |
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What if the employee has exercised some of his options and is a shareholder in the company but now wishes to resign or is asked to leave? |
Understand about the vesting period as well as exercise period. This is going to be your efforts for 3-5 years. So just take some extra care. |
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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 with the legal advisors. |
Check once the exercise price as well. The exercise price is typically the face value of shares. This can be even without any money as well. |
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ESOP schemes are audited and are referred to by auditors in their audit report. Accordingly, they cannot be back dated, especially when an audit report for the previous financial year has been prepared. Therefore, it is important to understand the legal regulations surrounding ESOPs before granting stock options to any employee. |
In nutshell, You only have a ESOP policy copy, whatever has been promised should be part of your copy of ESOP policy. That’s it. |
Let us understand with an example:
On September 01, 2016, a company grants its employee 150 options with a vesting period of three years and an exercise period of seven years at an exercise price of Rs 10 per share. Under the Company Rules, there is a one-year cliff period. This implies that the vesting will not commence till September 01, 2017. Since the vesting period is three years, one third of the options (i.e. 50) will vest on September 01, 2017 and the remaining one third on September 01, 2018 & last is on September 01, 2019. The exercise period of the vested options is seven years. This means that that the employee can convert his 50 options (that vested upon him on September 01, 2017) any time before September 01, 2024. For the second 50 options that vested in 2018, the employee can exercise his right any time before September 01, 2025. For the remaining 50 options that vested in 2019, the employee can exercise his right any time before September 01, 2026.
Let us now assume that on December 01, 2019, the employee decides to exercise his/her right to convert 70 options into shares. At that stage, an Exercise Application will be addressed to the company. Assuming the exercise price was Rs 10 per share, the employee will pay Rs 700 (70 options * Rs 10 per share) to the company and the company will allot the employee 70 equity shares.It is also pertinent to understand that in case an employee resigns, any unvested options (i.e. those that have not yet vested) will lapse. In case some options have already vested on the date of resignation, their treatment will be determined as per the terms of the ESOP scheme. Therefore, it is crucial that all employees who have been granted options read the terms of their company’s ESOP scheme very carefully.
In the end, I’d like to state that ESOPs are a great incentive for employees to put their heart and soul into an organisation. However, grant of options in itself does not mean that the employee will walk out of that organisation with millions in his bank account and employees should be conscious of this fact.
For more details or to draft your ESOP Services policy, please write us at hgoyal@especia.co.in
