What is ESOP?
ESOP stands for Employees’ Stock Option Plans. Here, employees receive an option to purchase a certain number of shares of the company. The price is negotiated between the employer and employee. The price of the shares is usually substantially lower than the market price of the shares, under ESOP schemes.
Why are ESOPs given?
ESOP usually acts as a reward to employees for a job well done. It is a kind of performance bonus. Employees who perform well receive an option to participate in the profits of the company.
From the perspective of the employer, ESOPs also act as a kind of corporate financing. This is because there is an influx of cash into the company.
How are ESOPs regulated?
ESOPs come under the Companies (Share Capital and Debenture) Rules, 2014. These rules lay down some types of compliance for setting up a stock option. It is very important to go through the compliance requirements before setting up a stock option plan.
Who can claim benefits under ESOP?
Only the following can claim benefits under an ESOP scheme.
- A permanent employee of a company working in or outside India.
- Whole time or part time directors of the company.
- An employee of a subsidiary company, whether in India or abroad, a holding company or an associate company.
It is important to note that a ‘promoter’ or director holding more than 10% of the equity shares of the company can take part in this scheme.
How to implement an ESOP scheme?
- An ESOP scheme must first drafted and presented in a shareholders’ meeting. It must receive approval by the shareholders. Till June 2015, there was need of a ‘special resolution’ to approve this scheme. Post June 2015, private limited companies do not have to comply with this requirement.
- After approval of ESOP scheme at the shareholders meeting, it is common to issue a Letter of Grant to the employee. This letter informs him of the options available to him under the scheme. A Letter of Grant should clearly indicate the vesting period and the manner of determining exercise price of the stock options.
- ESOPs come with a period known as vesting period. Employees can exercise their options only after the lapse of this period. It is a kind of lock-in period so that employees cannot immediately exercise them. If the employee leaves the organization before completing the lock in period, these stock options become invalid. The employee will not get any benefit in such case.
- If an employee wishes to exercise any of the options under the ESOP scheme, he needs to make an Exercise Application to the employer. It acts as a notice to the company, pursuant to which the options are converted into equity, for the employee to enjoy.
What are the benefits of having an ESOP scheme?
- They act as a great incentive to employees. Partaking in the profits of the company as a reward for good performance is a great motivation.
- The lock in period ensures that if an employee quits soon after receiving the stock option, that employee shall not enjoy the benefits of the scheme. This mitigates any unnecessary loss for the company.
- When employees receive shares of the employer company, they feel like they are more than just employees. They feel part of the ownership of the company. This is not only a great incentive, but also increases productivity. The better the performance of a company, the higher its share prices go. This directly benefits employees under ESOP schemes.
- It is beneficial for the company as a form of corporate financing.
- ESOP allows the company to provide performance bonuses for employees without having to spend extra money.
It is important to note that it is crucial to carve out an ESOP judicially. Moreover, the scheme should be well drafted and thoroughly debated among the shareholders.
Giving too many stock options may dilute the investors’ and promoters’ shares in the company. Legal advisers to the company should also vet an ESOP. This will help iron out any potential sources of complications in employer-employee relationships.
ESOP schemes are subject to audit and form part of the audit report. Thus, it becomes crucial to understand the legal regulations concerning ESOPs. It is only then the company should consider offering them to employees.
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