Freezing of Folios of physical shareholders... Last date for KYC is 30th September 2023... Act now Ref: SEBI Circular SEBI/HO/MIRSD/MIRSD-PoD-1/P/CIR/2023/37


What happens to ESOPs during the event of a merger or acquisition, or a change in control?

ESOP Services

What happens to ESOPs during the event of a merger or acquisition, or a change in control?

ESOP meaning A stock option (“ESOP”) is a derivative of the underlying equity share, every change in the share’s value has a direct effect on the Employee Stock Option Plan‘s value. The shareholders of a participating business are rewarded by a share exchange in a ratio that equates the pre-event and post-event value for the shareholder in any corporate restructuring event such as a merger, amalgamation, demerger, acquisition, etc. (“M&A”). The holders of the Employee Stock Option Plan must be treated in the same manner. This is a legal as well as a logical necessity.

The fair and reasonable (“FAR”) adjustment for employee stock option scheme (prompted by legal restrictions) demands an adjustment in the number and exercise price of ESOPs without increasing the vesting term and life of ESOPs, whereas the share exchange ratio is based on the comparative “worth” of the shares. In shares, the basic idea of matching the before and post value is the same.

Employee Stock Option Plan (ESOP) is a plan/scheme implemented by a corporation in line with applicable laws and regulations to allow workers to participate in the ownership of the firm by purchasing equity ESOP shares at a pre-determined price. It is a type of benefit plan that allows employees to become shareholders in the firm, as well as a significant tool for attracting and retaining talent.

In today’s scenario, startup ESOP/ESOP in a startup is significantly gaining popularity over time, as the business is still in its early stages and would rather implement these schemes in order to retain talented employees, as well as the fact that the burden of paying large salaries to employees can be neutralised by bringing in such motivated benefit plans and rewarding employees for their contribution to the company’s business.

Employee Stock Purchase Schemes (ESPS), Employee Stock Ownership Programs (ESOPs), and Employee Stock Options Schemes (ESOS) are some of the most common employee compensation plans in India.

MUDS is a prominent ESOP Advisory Services and Equity/ESOP Taxation Planning firm/consultant in Noida, Delhi, Gurgaon, and other Indian cities.

How does one defines or computes “the Value” that must be equal is a moot point? 

It is very straightforward in the case of shares; for listed shares, it is the price at which the shares are exchanged; for unlisted businesses, it is the Fair Market Value of the shares determined using accepted valuation methodologies. The intrinsic values are used in the share swap. Most firms (at least in India) use the same methodology (intrinsic value) to arrive at Option swap decisions (the ratio is the same as share swap). Co-A, for example, combines with Co-B. Shareholders of Co-A will get two shares of Co-B in exchange for one share of Co-A. Using this concept, Co-A ESOP holders receive the following FAR adjustment based on the intrinsic value method:

Particulars Pre M&A details Post-M&A revised details
Number of Employee Stock Option Plan 1000 ESOPs of Co A 2000 ESOPs of Co B
Exercise price Rs. 50 Rs. 25
Other terms as to remaining vesting period/ exercise period As originally prescribed No change (as originally prescribed)

Option Fair Value (using Black & Sholes or a comparable binomial model) is another technique of equating the value. Because SEBI is silent on which technique should be used to restore the value of Employee Stock Option Plan, a few firms review both procedures as a matter of prudence, caution, and record to use the one that is most advantageous to employee stock option scheme holders.

Change-in-control (“CIC”) in a corporation is necessitated by relinquishing more than fifty percent of controlling stake, either directly or indirectly, with the majority of changes occurring in the Board of Directors (“Board”), with or without changes in Top Management. Even if the market valuation may change based on perception after the CIC, the firm remains the same with the same equity shares. As a result, any FAR adjustment to ESOPs is not lawful. Other modifications, such as accelerated vesting, invocation of Tag along, or Drag along with provisions as per the employee stock option scheme rules, may be triggered by CIC. Employees then become shareholders with the same rights as other shareholders and can participate in the transaction that triggers CIC.

If the Employee Stock Option Plan plan does not allow for any acceleration or Tag / Drag along, workers will continue to retain their employee stock option scheme on the same conditions as before unless a CIC transaction is offered.

In a nutshell, due to the FAR adjustment imposed by law, the destiny of employee stock option scheme in M&A scenarios stays unchanged. CIC, on the other hand, is subject to the terms of the employee stock option scheme.

Before implementing such methods, a number of factors must be reviewed and analysed, including:

1) ‘ESOP Pool’ Provision: The ESOP plan is often implemented for chosen employees in organisations, based on their talents and experience to affect the company. We must determine the maximum number of equity shares in the form of equity incentive plans that the Company will make available for the granting of options to the company’s workers, executives, and directors in accordance with this ESOP.

For example, a percentage of equity provision, such as 5% or 10%. As a result, the provision would be included in Charter papers, with revisions made in the MOA and AOA, respectively.

2) Table of Capitalization and Shareholding Structure

To identify the pool and continue capital structure planning when the ESOPs are in place, understand the entity’s present capital structure and ownership owned by various shareholders.

3) Identifying personnel that are eligible

Employees who may be eligible for ESOP provision will have their eligibility requirements outlined. It might be the employee’s years of experience/technical know-how, performance record, and so on.

4) Term or Vesting Period

In accordance with the policy, we must establish the time during which the options will progressively vest/be accessible to the Employee.

A minimum of one year must elapse between the ‘gift of option’ and the employee’s vesting/exercise, as required by law.

5) The Time When You’re Locked In

For the shares granted in accordance with this ESOP, the Company will establish the period during which an employee may not sell, transfer, or otherwise dispose of the shares allotted.

6) Exercise Price 

We must indicate the pre-determined price at which the Board will designate the exercise price per share to be done by the employee at a later date, and so on.

7) Terms of Tax Liability

Provision will be made for tax responsibility, which includes the costs, expenditures, and liabilities associated with the payment of any and all taxes, stamp duties, levies, and charges imposed by relevant legislation, regardless of whether the employee or employer is involved. This would be defined absolutely.

8) Provision for Cancellation

Specifying the different conditions in which the corporation would cancel shares given according to an ESOP, such as termination, behavioural problems to the organisation, and so on.

MUDS Assists in Providing ESOP Services

  • India’s best end-to-end ESOP services
  • Retention of important team members is popular among start-ups.
  • For key workers, the ESOP scheme has been closed for the past 78 years.
  • For questions, complete the ESOP documentation, valuation, and employee training.
  • Relax by outsourcing ESOP services.
Previous Post
Newer Post