Introduction
Entrepreneurship, startup, and unicorn are new buzzwords that have made their way into the lexicon of modern India. India has seen a massive surge of entrepreneurship, as a result of which countless startup owners have acquired prominence and popularity, propelling them to the forefront of their own companies. However, because most emerging startups are bootstrapped, finding and maintaining competent staff is a tremendous difficulty. In such cases, Employee Stock Option Plans (“ESOPs”) serve as a wonderful motivator for such companies to employ and retain resources committed to the company’s goal.
To summarise, ESOPs are a type of employee benefit plan that allows employees to gradually obtain ownership in the firm. As the firm grows and investors join in, the founders who initially elected to work without pay begin to feel the pinch and demand more assistance to supplement the amount of time and effort they are putting into growing the business. At times, after numerous rounds of investment, the founder’s/co-shareholding founder is substantially decreased, and in such cases, investors consider incentives such as ESOPs to preserve the founder’s/co-skin founder’s in the game. However, the Companies Act of 2013 prohibits the award of ESOPs to a company’s promoters/founders/co-founders.
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ESOPs under the Companies Act, 2013
ESOPs have shown to be a very successful tool for helping employees establish a stronger sense of belonging to the company by rewarding employees for their dedication and efforts on behalf of the company and making them essential stakeholders. However, as comprehensive as it may sound, issuing ESOPs to promoters has its own set of constraints. To begin, the Companies Act of 2013 forbids the award of ESOPs to promoters since they are expressly excluded from the definition of “employee.” As laid down in Rule 12 (i) explanation of the Companies (Share Capital and Debentures) Rules, 2014 (“Share Capital Rules“).
Are Startups exempted from granting ESOPs?
This restriction does not apply to startups registered with the Department of Industry and Internal Trade (“DPIIT”). This exemption is granted because, while startups are thriving in India, the early stages of a startup are fraught with several challenges in terms of operational expenses, limited capital, valuation concerns, and the restrictions imposed by the Companies Act, 2013. The Companies Law Committee (“Committee”) was formed to address the concerns above. The Committee recommended that, in order to encourage startups, this restriction imposed by the Companies Act, 2013 be relaxed to allow the issuance of ESOPs to promoters who may be working as employees, employee directors, or whole-time directors, allowing the promoters to benefit from increases in the company’s future valuation without negatively impacting the company’s finances during its initial years.
This exception was intended to foster a constructive environment by allowing start-ups to receive deposits without any upper restrictions for the first 5 years, allowing startups to issue ESOPs to promoters functioning as employees, and so on. As a result, a proviso to Rule 12 of the Share Capital Rules was carved out as an exception to a startup company registered with the DPIIT, stating that the conditions mentioned in sub-clauses I and (ii) of explanation to Rule 12 (i) of the Share Capital Rules will not be applicable to a startup company for 10 years from the date of its incorporation or registration.
But this exemption would cease to exist after the following two conditions are met:
- On completion of 10 years from the date of its incorporation/registration; or
- Any prior year’s turnover exceeded 100 (one hundred) crore rupees.
Grant of ESOPs to Promoters
Granting ESOPs to promoters during the early years of the firm allows the promoters to receive less salary, allowing them to contribute more to the company’s success. The infusion of money would assist the company’s market valuation to rise, and as the valuation rises, the promoters may take advantage of the ESOP plan while working as an employee, director, etc. To keep promoters interested and motivated in the long run, investors and company’s management tend to grant additional stakes to promoters through ESOPs to enhance their ownership and urge them to grow up their operations for the long term.
ESOPs: an effective tool to get co-founders on board
In addition to the foregoing, it is important to remember that the founder, along with a small team of persons, works from the beginning to establish a firm. After raising additional rounds of investment, the founder expands its business by hiring more manpower and skilled individuals; this may include onboarding a co-founder (depending on the skill set) at a later stage if the company is a registered startup; otherwise, a co-founder may be classified as a promoter and thus be ineligible for ESOPs. Even if the promoter is unable to provide a significant ownership interest to the co-founder, he or she can entice such a co-founder by providing ESOPs.
Onboarding a co-founder also reflects a positive approach in the eyes of the investor, as it shows that the founder is willing to not only grow his/her business in terms of profits, but also to build a strong foundation based on people who share the same vision or may be useful in terms of future growth of the startup.
Conclusion
The awarding of ESOPs to promoters is good from an investor’s perspective since it motivates the promoters to constantly work hard towards the company’s growth while diluting their controlling interest. In exchange, granting ESOPs to promoters helps them financially while also retaining their value in the firm.
The exemptions granted to new firms to offer ESOPs to promoters are a progressive step made by the Government of India to create a flourishing investment market and strengthen the Indian economy. To allow the budding startups to blossom into large corporations it is necessary to give these companies the desired breathing space in the initial years of establishment. Furthermore, from a promoter’s standpoint, issuing ESOPs might be viewed as a beneficial instrument for onboarding a co-founder at a later stage in the firm. ESOPs.
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