An increasing number of Indian companies are considering equity-linked incentive plans as an avenue to incentivize and retain their employees. Companies consider employee stock option scheme (ESOPs) for the following reasons:

  • The market pays the upside to its employees.
  • There is usually no cash outflow for the company.
  • Helps in retaining and attracting talent.
  • Provides a sense of ownership to employees.

Specific regulations governing ESOPs viz, Company law (“2013 Act”), SEBI Regulations, Foreign Exchange Regulations, etc., need to be evaluated while designing an ESOP.

Typically, for a private limited entity, most of the compliances are to be done under the 2013 Act. Once the draft ESOP policy is in place the Company should conduct the following corporate actions:

  • Finalize the capitalization table: Once the management has decided to implement ESOP, it is required to draw out the pre and post-capitalization table.
  • Finalize the ESOP scheme: The ESOP scheme is the fundamental document that lays down the rules and regulations within which the ESOP arrangement will work. There are various critical aspects of an ESOP scheme like administration rights, exercise period, vesting schedules, treatment of options on exit events for employees which are required to be agreed upon at the outset. Any additional requirements will require the ESOP scheme to be amended. So, it is important for the management and founders to understand the terms that are going into the ESOP scheme at the drafting stage itself before it is put forth for the approval of the Board and the shareholders.
  • Obtaining prior consents of the investors: Companies often do have investors on their cap table. Investors can have a certain reserve or affirmative voting rights which require the company to obtain prior approval of an investor before implementing a corporate action. ESOP implementation is typically one of such items. Companies are therefore suggested to be mindful of any such prior consent requirements which stem out of the articles of association or any other contractual documents like a shareholder’s agreement.
  • Board’s Approval: The Board of the company should approve the ESOP scheme once placed before and also provides the necessary authorization and sub-delegate its power to such other committees and any other group if the scheme so requires.
  • Shareholders’ Approval: The Company should hold an extraordinary general meeting to pass the shareholder’s ordinary resolution to approve and adopt the ESOP policy pursuant to the provisions of Section 62(1)(b) of the 2013 Act. It is also pertinent to keep in mind that the dispatch of the notice to the existing shareholders for convening the general meeting should be along with the explanatory statement disclosing certain mandatory points as per Rule 12(2) of Companies (Share Capital and Debentures) Rules, 2014 of the 2013 Act. These points mostly include the total number of stock options to be granted, identification of classes of employees entitled to participate in the ESOP scheme, appraisal process for determining the eligibility of employees, requirements and period of vesting, maximum period of vesting, exercise price, exercise period, process of exercise, lock in period, maximum number of options to be granted per employee and in aggregate, method of valuation of option and conditions for lapse of options and time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee.
  • Post ESOP scheme adoption compliances: Once the ESOP policy is adopted in the general meeting, the Company can grant ESOP to the identified employees by passing board resolution pursuant to provision of Section 62 (1) (b) and issue grant letter to identified employees of the Company. A necessary statutory register in SH-6 is to be maintained by the company with the details of grants.

If Company has granted ESOP options to non-resident identified employees, then the Company should file Form ESOP with the Reserve Bank of India through Single Master Form with FIRMs portal.

The Board of Directors, also, need to disclose in the Directors’ Report for the year, certain details of the ESOP including the number of options granted/ vested/ exercised, the total number of shares arising as a result of the exercise of the option, options lapsed, exercise price, variation of terms of options, the money realized by exercise of options, the total number of options in force, employee wise details of options.

While ESOPs are the most widely used mode by companies to attract, motivate and retain employees, employees also see this scheme as a long-term investment. Since many companies have now made ESOPs as part of the compensation plan for key employees, it is very important for the companies to ensure proper corporate actions are undertaken.

For any ESOP related query or assistance in structuring, implementing or managing your ESOP plans, reach out to us at: esop@algolegal.in

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