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In general, an Employee Stock Option Scheme is a collection of goals, concepts, and rules. It’s worth remembering that an employee stock option plan is a governed mechanism at any phase of the business if the firm is publicly traded or not.

The pertinent rules defining what is permitted and what is not, which constitute the four corners of the employee stock option plan, are the first item to review when determining the main components of an Employee Stock Option Scheme. These legal criteria apply to any articulation on ESOP Scheme design. The articulation focuses on the structure of the employee stock option plan, which outlines the intricacies of critical components and is mostly based on economic explanations of “why” and “how” an ESOP Program should be executed.

An ESOP SCHEME, or any of its variations, such as a Stock Appreciation Rights Scheme (“SAR Scheme”), a Restricted Stock Unit Scheme (“RSU Scheme”), or even a Phantom Plan, must have the essential components:

  • Establishing purposes such as reward/motivation for retention, performance, and so on are the primary goal(s).
  • Cash, stock shares, or a mix of the two are acceptable modes of payment.
  • In the case of equity shares, whether primary or secondary, the source of the shares is important.
  • Strategy for implementation: Direct or via a trusted party;
  • Employee levels/bands who may be qualified for financing; Coverage/selection criteria
  • For maintaining and inspiring talent, individual allocation is crucial.
  • Identifying the administrator is as follows: The administrator acts as the scheme’s key decision-making forum.
  1. The minimum and maximum vesting durations, as well as the vesting schedule and criteria, are all part of the vesting parameters.
  2. The exercise price that an employee must pay, as well as the time range in which ESOPs must be exercised, are examples of exercise criteria.
  3. Employee detachment: How  ESOP SCHEME are handled when an employee leaves for whatever reason;
  4. Other important themes include ESOP taxes, employee stock option plan rights clarification, a plan of action in the case of a corporate action such as a bonus issue, rights issue, merger, or other corporate action, data privacy protection, and jurisdiction.

Last, not the least

A significant and challenging component of an Employee Stock Option Scheme for an unlisted corporation is monetization (or what is generally referred to as “exit” or “liquidity”) of  ESOP SCHEME or ESOP shares. The unlisted ESOP regulation is silent on this, allowing for the best possible structure of when, how, and to what extent ESOPs or ESOP shares can be sold. Furthermore, what protections can be put in place if shares are issued in a closely held company to limit or avoid any risks posed by shareholdings by an employee, an ex-employee, or even a network of such employees?

Fine-tuning of these fundamental components in exact terms typically demands a review with reference to a company’s business plan in order to determine whether they are compatible to the ESOP Employee Stock Option Scheme objectives and provide a win-win situation for all stakeholders. As a result, while these basic components are the identical for all businesses, their specifics change on a regular basis and might vary significantly even within a single industry.

Why should you have an ESOP scheme?

Let’s take a look at the advantages of establishing an employee stock option plan (ESOP) now that we understand what it’s about.

  • A ready market for the firm’s owners’ stock: An ESOP allows the owners of a privately held firm to create a ready market for their shares among employees and directors.
  • ESOP owners can borrow money at a lower after-tax interest rate.
  • It also comes with a variety of tax benefits. Here are some of the advantages:
    • Stock contributions are tax-deductible, thus corporations can benefit from a present cash flow advantage by issuing new shares through an ESOP.
    • Cash contributions are tax-deductible, which means that a company may make annual payments to the ESOP and earn a tax credit in order to build up a cash reserve for future use.
  • The ESOP Scheme is a retainership mechanism that is essential for small businesses. This is owing to the fact that under this structure, workers may use their right to purchase shares during a lock-in period. If an employee chooses this option, he or she will be obligated to stay with the company for the duration of the lock-in term and will not be able to leave. This allows the firm to keep its employees.
  • Employee stock ownership plans ( ESOP SCHEME) instil a sense of ownership among employees. They feel they are not just employees, but also corporate owners. Because employees share in the earnings, they are more motivated and encouraged to fulfil the organization’s objectives (in the form of dividends).
  • It’s a non-monetary incentive that allows the company to compete for the best staff.
  • It also allows business owners to get liquidity without having sold the business to a competitor or other third party.

Essentials of Employee Stock Option Plan Scheme

Let’s take a look at the primary features that an ESOP plan must have now that you know why having one is so crucial.

Objectives of the Employee Stock Option Scheme

The clause stating the plan’s objectives is the first and most important element in an ESOP. Some objectives include providing an incentive to attract, recruit, and retain employees; motivating employees through reward prospects; instilling a sense of empowerment and providing economic growth opportunities for workers; facilitating the firm’s success and aligning the best interests of employees and the company, and so on.

Term of the Employee Stock Option Scheme

This clause establishes when and for how long the ESOP plan will be in effect. It might also provide details on if and how this ESOP scheme can be expanded.

Equity shares subject to the Employee Stock Option Scheme

The amount, as well as the price of the equity share, will be specified in great detail in this paragraph.

It is necessary to state the maximum percentage of total shares that can be issued under the  ESOP SCHEME programme. It might also say that the board of directors has the power to alter the maximum amount using the right way (like a resolution).

The face value of each equity share distributed under the programme must also be specified in the provision. It might also say that the board of directors has the power to impose additional terms and conditions for these equity shares.

Eligibility criteria

This section discusses in detail how an employee may be eligible for a grant or vested option. The criteria might include, among other things, the number of years of continuous service or the attainment of certain performance goals. It may include the employee’s seniority, length of service, merit and performance record, as well as future potential performance.

Grant of options

A grant is the process through which the business issues shares, options, or other benefits under the employee stock option plan. On the award date, the compensation committee or any comparable body authorises the grant.

This section explains how workers that match the criteria will be found and enrolled in the programme. It would also state the grant’s price and the method by which the grant’s price would be set. It may, for example, say that the grant price of the ESOP will be established by the board of directors.

This restriction should also include the maximum amount of time an employee has to accept the prize. It may also say that the employee has no rights to the option until he or she converts his or her option into a share, including the right to a dividend and/or a vote.

Vesting of options

Vesting is the process through which an employee can apply for company shares in return for the rights granted to him or her. The vesting period is the time period over which an employee can execute his or her option of buying shares in the firm.

Under these circumstances, the vesting period must be as long as feasible. The board of directors, the compensation committee, or any other organisation recognised for this purpose may also specify the lock-in time.

To further understand this phrase, consider the following example: From the day the option was granted, the maximum vesting period would be one year. Subject to this maximum time, the board of directors shall have the right to decide the maximum vesting length for the equity shares awarded under this ESOP.

Option exercising plan and consideration

This phrase would specify the cost and duration of the exercise. The exercise price is the commission paid by an employee who wishes to exercise his right to own firm shares. Following vesting, the employee must exercise his entitlement to apply for business shares and make the requisite payments during the exercise period.

This clause might, for example, specify that the exercise time will be two years from the date of vesting and that the exercise price and payment method will be established by the board of directors/compensation committee, and so on.

This clause should also clarify whether the company intends to provide employees with any type of bridge money as a result of this.

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