Startups are increasingly announcing ESOP buybacks to retain and hire top talent amid the growing competitive market. Recently, Cars 24 announced a Buyback of ESOPs worth Rs. 75 Crores. There are many more companies announcing such buybacks. But the real question is what is the Buyback of ESOP? How does it work? Legally and Practically.
Before we learn the Buyback of ESOP, it is important to understand what ESOP is and What is Buyback. Let us start ESOP
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ESOP
Employee Stock Options Plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company; this interest takes the form of shares of stock. So ESOPs are offered to employees of the Company to allow the Employees to participate in the growth of the Company.
Advantages of ESOPs
- motivate employees and improve their morale
- reward employees for their commitment and performance
- Wealth creations for Employees.
How ESOPs work?
Generally, Company allots ESOPs to its Employees under a Plan or a Scheme where shares get vested (allotted) in a period ranging from 1 year to 5 years and so on.
Example: Mr. Das has joined ABC Startup on January 1, 2022, has got 10,000 ESOPs. These 10,000 ESOPS will vest in the following manner. 1st year 10%, 2nd year 20%, 3rd year 30% and 4th year 40% (these year and % are flexible and can be decided by the Company)
So Mr. Das will be eligible to apply for shares as per the following:
| On or after January 1, 2023 | 1,000 Equity Shares (10%) |
| On or after January 1, 2024 | 2,000 Equity Shares (20%) |
| On or after January 1, 2025 | 3,000 Equity Shares (30%) |
| On or after January 1, 2026 | 4,000 Equity Shares (40%) |
So in our example, the dates when Mr. Das becomes eligible to subscribe or apply for Equity Shares under ESOP Scheme are called as Vesting Period.
These ESOPs and shares have huge value when the companies are listed on recognized stock exchanges and where Employees can sell these shares easily on the open market. For Eg: if a TCS issues ESOPs and its employees who have got shares under the ESOP scheme can sell it off in Open market/stock exchanges at the prevailing rate. This makes ESOP a liquid asset and employees can see its value or wealth created.
However, in the case of Startups or unlisted companies, ESOPs/Shares does not have the same value as Shares of listed Company due to the unavailability of the Direct Market. To mitigate this problem, many startups have started buying back the ESOPs issues to their employees.
So coming back to our example, let’s Presume as on January 1, 2026, Mr. Das instead of paying for all 10,000 shares, to the Company, the Company buyback ESOPs issues to Mr. Das at the prevailing market rate (latest round done by the Company) after deducting price Mr. das is supposed to pay for subscribing the shares. The ESOP Buyback is one of the biggest wealth creators for startups in the last few years in India.
Before we get into that, let us understand what is BuyBack under the Companies Act, 2013?
Buy-Back is a corporate action in which a company buys back its shares from the existing shareholders by utilizing its Free Reserves or issuance of another Security. A buyback allows companies to invest in themselves.
As per Section 68(1) of the Companies Act, 2013 Buyback can be sponsored out of—
(a) its free reserves;
(b) the securities premium account; or
(c) the proceeds of the issue of any shares or other specified securities.
What are the Securities allowed to be bought back by the Company?
As per Section 68 (1) of the Companies Act, 2013, A company may purchase its own shares or other specified securities. As per Explanation 1 to Section 68, “specified securities” includes employees’ stock option or other securities as may be notified by the Central Government from time to time.
Therefore, Employee Stock Options (ESOPs) which are not yet converted into the Shares of the Company shall also be considered as a Security for the purpose of Section 68 of the Companies Act, 2013. Additionally, Section 68(5) provides that :
The buy-back under subsection (1) may be-
(a) from the existing shareholders or security holders on a proportionate basis;
(b) from the open market;
(c) by purchasing the securities ISSUED to employees of the company pursuant to a scheme of stock option or sweat equity.
Section 68 (5) makes it very clear that the Company can buy back its Securities as well as Issued ESOPs.
Process for Buyback of ESOPs
Interestingly, Section 68 provides for the Buyback of ESOPs and enables the Company to buy back ESOPs issued to employees, it does not provide a detailed process for the same. Also, technically, ESOPs are not a Security as per the definition provided under the Companies Act, 2013, and hence, the Company is neither required to file PAS 3 for granting of ESOPs nor it is required to comply with the requirement of Private Placement or Rights Issue while granting ESOPs.
This position makes buyback of ESOPs bit tricky as despite, ESOPs are legally recognized and Buy-Back is permitted, it is not reflected in Books of Accounts of the Company till the time the same ESOPs which are granted are subscribed and relevant Security is issued against the ESOPs. Therefore, while buying back of ESOPs, the process required is bit different.
The process of Buyback of vested ESOPs
- Shortlisting candidates for buyback;
- Calling Board Meeting and take obtain approval of the Board for Buy-Back of ESOPs utilizing the Funds as specified in Section 68(1) of the Companies Act, 2013.
- Sending intimation letter to eligible Employees informing Companies Intention to Buy Back of ESOPs.
- On Receipt of confirmation and consent from the Eligible Employees, initiate the process for cancellation of relevant ESOPs and make payment to them
- While making payment for ESOP, remember that the amount will be treated as Perquisites in the hands of the Employee and hence Employer (the Company) needs to deduct necessary taxes.
- Once the buyback is completed, Company needs to update its Register (SH-10) of Buyback with the following details:
- the consideration paid for the shares or securities bought back,
- the date of cancellation of shares or securities,
- the date of extinguishing and physically destroying the shares or securities and such other particulars as prescribed under the Rules.
There are companies like Healthifyme, Zetwork, Swiggy, etc have also completed the buyback of ESOPs recently.
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