ESOP (Employee Stock Option Plan)

Employee Stock Option Plan (ESOP) is an option given to directors, officers or permanent employees of a company to purchase or subscribe the securities offered by the company at a future date, at a concessional price generally.

As per Section 2(37) of the Companies Act, 2013 employees stock option is the option given to the directors, employees or officers of the company or of its holding or subsidiary company, the right to purchase or benefit or subscribe for the shares of the company at a predetermined price on a future date. Thus, ESOP is a scheme where a company proposes to increase its subscribed share capital by issuing further shares to its employees at a predetermined rate.

Under Section 62 (1) (b) of the Companies Act 2013, where at any time a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares may be offered to employees under a scheme of employees’ stock option, subject to a special resolution passed by the company and subject to such conditions as may be prescribed.

Any company can issue ESOP. All companies other than listed companies should issue it in accordance with the provisions of the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014.

• ESOP CAN BE ISSUED TO:

Rule 12(1) of Companies (Share Capital and Debentures) Rules, 2014 states that ESOP can be issued to the following employees:

1. A permanent employee of the company who is working in India or outside India.
2. A Director of the company, including a whole-time or part-time director.
3. A permanent employee or director of a subsidiary company in India or outside India, or holding company of the company.

• ESOP CANNOT BE ISSUED TO:
• An independent director.
• An employee who is belonging to the promoter group or is a promoter of the company.
• A director who either himself or through anybody corporate or through his relative holds more than ten per cent of the outstanding equity shares of the company, whether directly or indirectly.

Note: in case of a startup company, point (2) and (3) shall not apply up to ten years from the date of its incorporation or registration.

• PROCEDURE FOR ISSUE OF ESOP:

1. Draft the ESOP Scheme.

• Convene the Board Meeting and pass the scheme.

• Call the general meeting to approve the scheme by Shareholders. The following disclosure will be made in the explanatory statement annexed to the notice for passing of the resolution-
• the total number of stock options to be granted.
• identification of classes of employees entitled to participate in the Employees Stock Option Scheme;
• the appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;
• the requirements of vesting and period of vesting;
• the maximum period within which the options shall be vested;
• the exercise price or the formula for arriving at the same;
• the exercise period and process of exercise;
• the Lock-in period, if any;
• the maximum number of options to be granted per employee and in aggregate;
• the method which the company shall use to value its options;
• the conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct;
• 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.

• Approve the ESOP Scheme by passing a special resolution (ordinary resolution in case of Private Company). The approval of shareholders by way of separate resolution shall be obtained by the company in case of-
• grant of option to employees of subsidiary or holding company; or
• grant of option to identified employees, 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 of option.

• File form MGT-14 to submit the special resolution within 30 days of passing the resolution.
• After approval of ESOP scheme by the shareholders, grant options to the eligible employees.

• Vesting of Options. There shall be a minimum period of one year between the grant of options and vesting of options.

• Exercise of Options by the employees.

• Allotment of Shares. As and when options are exercised file form PAS-3 (Return of Allotment) with ROC.

1. The company shall maintain a Register of Employee Stock Options in form SH-6 and shall forthwith enter therein the particulars of option granted.

1. The Board of directors, shall, inter alia, disclose in the Directors’ Report for the year, the following details of the Employees Stock Option Scheme: options granted, options vested, options exercised, options lapsed, total no. of shares arising as a result of exercise of option, money realized by exercise of options, the exercise price, employee wise details of options granted, etc.

Note: If a private company wants to issue ESOP, then it should ensure that the Articles of Association (AoA) authorises for issuance of shares through ESOP. If the AoA does not authorise, then the company should first hold an extraordinary general meeting to alter the AoA to include the provisions of issuance of shares through ESOP and then proceed with holding the board meeting for the passing of the resolution and getting the shareholder’s approval for ESOP Scheme.

• ALLOTMENT OF ESOP:

There are three terms that are mainly focused on the time of issuance of shares through ESOP to the employees. They are as follows:

1. GRANT: Grant means the issue of stocks to the employees. It means informing the employee that he is eligible for ESOP. The company will have the freedom to determine the exercise price while providing the option of ESOP to the employees.
2. VEST: Vest means the right of the employees to apply for the shares granted to them. There shall be a minimum of one year between the grant of option and vesting of option for the ESOP scheme.
3. EXERCISE: The exercise period is where the employees can exercise the option of buying the shares. The company will have the freedom to specify the lock-in period for the shares issued (if any) after the exercise of the option. The employees will not have the right to receive any dividend or to vote or enjoy the advantages of a shareholder in respect of the ESOP granted to him until the shares are issued on exercise of his option.

• SOME IMPORTANT PROVISIONS:

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

• 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.

• 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.

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

• 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.

• The amount, if any, payable by the employees, at the time of grant of option-

may be forfeited by the company if the option is not exercised by the employees within the exercise period; or the amount may be refunded to the employees if the options are not vested due to non-fulfillment of conditions relating to vesting of option as per the Employees Stock Option Scheme.

• ESOPs granted to directors become part of managerial remuneration.

• RESTRICTIONS:

1. The option granted to employees shall not be transferable to any other person.
2. The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.
3. Subject to clause 4, no person other than the employees to whom the option is granted shall be entitled to exercise the option.
4. 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.
5. 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.
6. 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.

MODES OF ISSUANCE OF ESOPs:

1. Direct Route:
2. In Direct route, the company grants the options to the employees directly.
3. At the time of exercise, fresh equity shares are allotted to the eligible employees which makes them the shareholders of the company.
4. Direct route is generally preferred by unlisted companies.

• Trust route:
• In the Trust route, the company creates a Trust specifically for the purpose of running the ESOP scheme.
• The company grants a loan to the ESOP Trust to acquire shares. Since the ESOP Trust is not a business trust; therefore, the ESOP Trust on its own will not have funds to be able to acquire the shares from the secondary market. It is specifically created with the objective of issuance of ESOPs to the employees.
• At the time of exercise by the employees, the ESOP Trust first acquires the shares from the secondary market/ company and then it transfers the shares in the name of the eligible employee.
• When the employee leaves the company, they have an option of selling back the shares to the ESOP Trust or the secondary market.
• Trust route is generally preferred by the listed companies.