World of ESOPs is known for more than a decade: Stock options or Employee Stock Option Plan (“ESOP”) is an employee benefit plan which involves giving an option to the employees, either to buy the stocks at a rate below the prevailing market value or a certain percentage of the employee’s remuneration being provided as stocks of the company. There are various variants of ESOPs – Employee Stock Option Plan (“ESOP”), Employee Stock Purchase Plans (“ESPP”), Restricted Stock Units (“RSUs”), Stock Appreciation Rights (“SARs”), Phantom Stock Options.

Particulars ESOP ESPP RSU SAR Phantom Stocks
Mechanics Grants option to employees to acquire shares at future date at a pre-determined price (lower than prevalent market price) Employees are given the right to acquire shares of the company at a discounted price Company provides stocks to employees which vest over a vesting period Stock units are hypothetically granted at an issue price to employees with predetermined vesting period or conditions Those units of SAR’s which are settled by cash settlement. These are 2 of types viz. appreciation only and Full value
Vesting and exercise of options ESOP acquisition is on vesting within the exercise period Shares are offered to employees for immediate purchase with no vesting or exercise period Issued at FMV through vesting plan after fulfillment of predetermined conditions. On vesting of the SAR, bonus shall be given to the employee On vesting of Phantom Stocks, cash bonus shall be given to the employee
Post-exercise conditions/ restrictions Employees can sell the shares subject to lock-in period if any The shares may be subject to lock-in to prevent the immediate sale of acquired shares Upon vesting, employees can sell RSU at their discretion No such conditions prescribed No such prescribed conditions

While Wipro (in 1985) was the first company to coin ESOP, ESOP gained prominence in India with Infosys public discourse in 1990. The importance of ESOP is well established as a prodigious tool of corporate ownership, employee attraction/retention/wealth creation, etc. However, post-incorporation of ESOP accounting and taxation, there was some diminution in the overall appeal of ESOPs.

And their prominence increases year-after-year; an evergreen tool: With acceleration in India’s economic and earnings growth, PE valuations (perceptions) keep improving. ESOP once again have assumed their strategic appeal, especially in the start-up world. In the start-up ecosystem where innovation is changing business models, ESOP occupies a prominent positioning. Stock options/ESOPs are the best way start-ups can establish a bond with their employees and manage to pay high salaries to attract the best talent.

With India being the third-largest start-up economy and experiencing a decadal wave of Unicorns/Soonicorns and the emergence of Serial Entrepreneurs, ESOP will remain an evergreen tool of rewarding human intellect and encouraging long-term thinking. The other fundamental reason why ESOPs have gained popularity in recent times is the increase in the number of sales and opportunities to monetize.

Recent ESOPs issuances in the start-up world are a good testimony: The recent companies/start-ups which announced ESOPs for their employees include PhonePe, Licious, ShareChat, Wakefit, etc. These start-ups adopted ESOPs during the pandemic having seen traction in their growth/revenues and at the same time felt it was equally critical to attract, retain and share gains with the valuable human asset. In 2020, this was also adopted as a tool to conserve cash and motivate people to create new growth orbits for the organizations.

India (more specifically the start-up economy) can be on its journey to replicate the success as experienced in the United States: Few stats from throw interesting thoughts-

  • As of 2021, the National Center for Employee Ownership (NCEO) estimates there are roughly 6,600 Employee Stock Ownership Plans (ESOPs) covering more than 14 million participants.
  • 95% of 2020 “100 Best Companies to Work For” have employee ownership.

ESOP awards from a process perspective: Section 62(1)(b) of the Companies Act, 2013 that deals with ESOPs, outlines the process around granting, vesting, and exercising. The exercise price is the pre-determined price at which the employee will buy the shares. Companies, where procedures are implemented for ESOP, are listed companies, unlisted companies, start-ups, private limited companies, holding company and subsidiary companies. The procedures center around the development of a suitable ESOP plan, adherence to relevant laws, drafting of the ESOP scheme, changes if any in the Constitution of the company, Board Meetings/General Shareholder meeting to approve the scheme, and the assessment on the valuation of the company. Accordingly, appropriate documents are filed with the Ministry of Corporate Affairs.

Approaches to best practices in ESOPs: Some of the best practices to implementation of ESOP plans would include:

  • ESOPs should have a good co-relation with the vision, growth, financials and long-term plans of the company. While ESOPs share ownership amongst employees and creates belongingness, there should be room/ provision for incentivizing specialists (or top rankers).
  • ESOPs should drive objectivity and should be linked to consistent performance, tenure etc.
  • ESOPs should be best measured from a unit perspective rather than pure currency based to take care of dilution in the future.
  • Liquidity events: ESOPs can be partially or completely monetized on liquidity events such as buybacks, secondary sales, or an IPO. For example, Flipkart stands out in not just the doling out of ESOPs but the sustained focus over the years of creating ‘liquidity events’ at regular intervals for employees so that they do not have to wait for an IPO or listing to cash out their ‘earnings’. Creation of regular buyback opportunities will enable employees to encash (subject to eligibility/ vesting time etc.) and replenish the ESOP pool.

Understanding Tax Implications in India on ESOPs: In India, ESOPs are taxed at 2 instances:

  • As a perquisite, which is the difference between the Fair Market Value (“FMV”) on exercise date and exercise price. Here, the employer deducts tax on the perquisite. From the FY 2020-21, an employee receiving ESOPs from an eligible start-up need not pay tax in the year of exercising the option. The tax deducted at source on the ‘perquisite’ stands deferred to earlier of the following events: (1) expiry of five years from the year of allotment of ESOPs, (2) date of sale of the ESOPs by the employee, (3) date of termination of employment.
  • As a capital gain at the time of sale by employee: When the employee sells his/her shares, the difference between sale price and FMV on the exercise date is taxed as capital gains (based on the holding period).

Algo Legal’s end-to-end role in ESOP Plan: Design, Implementation, Roll-out, Exercise and Monetize:

  • ESOP scheme advisory and preparation
  • ESOP Trust Formation
  • Tracking of Vesting Schedule
  • Corporate Law Advisory
  • Tracking of Cap Table
  • Tracking legal documents and filings
  • ESOP Trust administration & Compliance
  • Tax Advisory and Computations
  • Corporate Secretarial Compliances
  • ESOP Accounting Advisory
  • Special advisory including start-ups recognition, 80-IAC certificate, angel-tax exemption, etc.

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

This material and the information contained herein prepared by Algo Legal is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). Algo Legal is not, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision. Algo Legal shall not be responsible for any loss whatsoever sustained by any person who relies on this material.