In India, over the last 2 decades, Employee Stock Options (ESOP) has become one of the most important components of compensation structures, especially in the start-ups which usually don’t have the money power to attract good talent. Let’s say, a start-up company ABC Pvt. Ltd. with 2 (two) founders is developing a unique technology to solve a pressing problem, then it needs to hire extremely good and experienced people from large corporations.
The founders may be able to attract talent by showing their long-term vision and future-plans but paying the market salaries to experienced candidates can sound like a death knell for most startups. This is where ESOPs come into play where your employees will become part owners when you give them equity and if the startup happens to be acquired or goes public, the value of the given shares goes many times up in its value. There have been stories of many startup employees with ESOPs turning into millionaires after vesting their shares. Flipkart and PayTM are two names that featured prominently in the country for creating wealth for its initial employees.
ESOP has been an instrumental tool in bridging the gap of cash salary vs market salary, wherein the company would pay certain amount as cash compensation and the balance in the form of ESOPs, which shall be earned out with the growth of the company. It is the mechanism by which employees are compensated with increasing equity interests over time.
The following are the important aspects of ESOPs in relation to the legal framework, procedure for its issuance, tax implications upon its exercise and on sale, its compliances and reporting:
1. Legal Framework:
With the promulgation of Companies Act, 2013, specific provisions for regulation of ESOPs have been framed by the lawmakers. As per the new Act, issue of Employee Stock Options is governed by the provisions of Section 62(1)(b) of the Companies Act, 2013, read with Rule 12 of Companies (Share Capital & Debenture) Rules, 2014, and SEBI (Employee Stock Option Scheme & Employee Stock Purchase Scheme) Guidelines, 1999.
2. Eligibility Norms:
ESOPs can be given to permanent employees, directors and officers of the parent company or its subsidiary, whether in India or outside India, but does not include:
Provided that in case of a startup company, as defined in notification number GSR 180(E) dated 17th February, 2016, issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry Government of India, Government of India, the conditions mentioned in sub-clause (i) and (ii) shall not apply up-to five years from the date of its incorporation or registration.
3. Procedure Involved:
4. Tax Implications:
5. Compliances and Reporting:
The company shall hold a board meeting to consider the ESOP scheme and hold a general meeting to pass ordinary resolution to approve the scheme. In case the grant of options exceeds 1% of the issued capital, then the company needs to pass a special resolution at the general meeting.
The rules governing ESOPs allows companies to amend its ESOP scheme at any time by passing a special resolution approving such amendment, however, the amendment must not be unfavorable to the existing ESOP holders. Further, there shall be certain restrictions like minimum period of one year between the grant of options and vesting of options and non-transferability of options granted. The options granted shall not be pledged, mortgaged or otherwise encumbered or alienated in any other manner.