Employee Stock Option Plan (ESOP) - taking story further

RECAP of ESOPs 

Under ESOP the employees have the right to acquire shares of the company in future at a pre-determined price. The right to acquisition of shares (option) is provided under a scheme (grant of option) and the option may be exercised after a certain number of years (vesting period) at a pre-determined price (exercise price). Therefore, if the company over the years (vesting period) does well, then the employees will be able to encash on the increment in wealth of the company by acquiring shares. The difference between the exercise price and the-then value of the shares is effectively the value addition the employees have been able to contribute and therefore participate in the same. Sometimes these schemes also allow the employees to extract the value additions in hard cash terms rather than holding shares in the company.

NOW ARTICLE CONTINUES.......

5.3.1.2 Situations in which Directors are eligible: 

Following directors are also eligible for ESOS shares under this Act: 

(i) Director holding more than 10% equity shares in the subsidiary or holding preference shares (including convertible) in the company. 

(ii) As aggregate holding of all directors need not to be considered here even if they hold upto 100%, still they are eligible in case each director either directly or indirectly does not individually hold more than 10% equity shares of the company. 

(iii) Directors holding upto 10% of holding company of the company are also eligible for ESOS.

5.3.1.3 Other noteworthy points- employee definition 

Eligibility barrier of more than 10 % shareholding is applicable only in case of directors not to permanent employee. 

However, if employee becomes a promoter or a person belonging to the promoter group, then he shall not be eligible employee under this rule for ESOS. 

5.3.2. Promoter: 

The word ‘promoter’ defined under clause (69) of section 2 of the Act shall be taken into account while determining the status of employee whether he is a promoter or not. This definition is an exclusive one. As per three sub-clauses of the definition the following persons fall into category of promoter as follows: 

    (i) a person named as promoter in the prospectus or 

    (ii) a person identified as promoter in annual return filed under section 92 or 

    (iii) a person having direct or indirect control over the affairs of the company as a shareholder or director or otherwise. 

    (iv) a person in accordance with whose advice, directions, instructions the board of the company is accustomed to act.

5.3.3 Practical issues: Promoter definition: As it was discussed earlier, ESOS is best option adopted by the companies especially start-up companies particularly technology driven companies across globe. Technocrats behind creation of company once named as promoters would be not eligible for ESOS. 

The promoter definition creates a problem to startup companies from rewarding / remunerating their hard-core-working-employees / directors by way of ESOS, if they are named as promoters. Cashless remuneration by way of ESOS is best model to save the capital outlays and which is essential at early stage. The definition of promoter needs be relaxed to private companies for ease of doing business, as issue of ESOS is regulated by the Act.

Illustration: Majority cases two or more persons say from IITs(technocrats) joining together to create a company. By using their knowledge and wisdom they may develop a particular innovative product. They may not have required funds to exploit their innovative. Banks may not be ready to fund their projects as there was no track record behind them. Venture capitalists / angel funds / HINS/ FII (investor) only show interest in investing these start-ups for commercial exploitation of product. 

As part of investment requirement, the investors shall invest in structured securities either optionally or fully convertible. As provided in the Act, indirectly they would be having control over the affairs of the company. Also operations of the company are particularly driven by shareholder/share subscription agreements through entrenchment provisions at articles. These agreements identify these technocrats as promoters and investor as investors. 

The said agreements invariable provide for ESOS/ sweat equity to technocrats. But the Act does not permit them. These technocrats work for company as their pet baby even not taking any monetary salaries. The investors though having control over affairs of the company would not be interested to name them in the annual return as promoters. The technocrats once they are named as “promoters” at annual returns, they shall be debarred from participation in the ESOPs scheme.

5.3.4 Promoter Group: The expression ‘promoter group’ is not defined either in the rules or Act. However, it is defined SEBI-SBEB regulations by giving a mere reference to definition provided under SEBI-ICDR Regulations, 2009. 

Provided where the promoter or promoter group of a company is a body corporate, the promoters of that body corporate shall also be deemed to be promoters of such company;” 

In case of unlisted company or private company, the above definition provided in SEBI-SBEB Regulations, can be referred by using the rule of maxim ‘pari-materia’ as observed by the Supreme Court on various cases stating “Words and expressions defined in one statue as judicially interpreted do not afford a guide to construction of the same words or expressions in another statute unless the both the statutes are ‘pari-materia’ legislations or it is specially so provided in one status to give the same mean in to the words as defined in other statue. To the latest sitautions, the Supreme Court referred the parimateria in case of State of Gujarat & amp; Anr. v. Hon’ble Mr. Justice R.A. Mehra (Retd.) & amp; Ors., JT 2013(1) SC276.

Pari-materia means: The phrase used in connection with two laws relating to the same subject matter that must be analyzed with each other. 

Pari-materia legislations: More the one legislations are related to same subject.

5.4 Operative Parts:  

# Option granted to employees are not transferable to any other person.

# Exercise period – the Pre-determined period within which the option must be exercised by the employee. There must be a minimum period of one year between the grant of option and vesting of option.

# Vesting period is the amount of time the employee needs to work with the company to be eligible for the ESOP.

# It can’t be offered to Promoters or Directors who directly or indirectly hold 10% shares in the company  nor can be offered to  non-employees. A big Hurdle as we look at the illustration above.

# There is no ready market for shares of an Unlisted private limited company unlike listed companies. Marketability of such shares are generally discussed at the time of launch of the scheme and generally promoters come forward with assurances and commitment through scheme document.

# Employees would have following Exit options for disposal of shares:

        @ IPO

        @ To Strategic buyer / Investor, etc

        @ Company buyback

        @ Selling to an external buyer, subject to the Articles of Association.

5.5 Granting of Options: Granting means giving the ESOPs by the company and receiving it by the employee.

Once the scheme of ESOS is framed with approval of shareholders, the board may identify the eligible employees. It is purely discretionary power of the board to identify the eligible employees within such hierarchy as per scheme. 

It is again discretionary power of the board to include all employees or not in the ESOS. A company can choose to whom to include in the ESOS and whom to exclude. No employee can demand to include his name in the eligible list of employees. 

By way of formal letter or through interact net or appraisal letter, the identified employees will be given such number of options with a right to exercise by subscribing or buying underlying shares of the company after vesting of same in his favour. The communication of granting of options generally contains the terms and conditions of options such as number of shares, exercise price, market price of the share if any, time of vesting, manner of exercise, taxation issues, rights and obligations of employees, treatment of options in the event of resignation or termination such other particulars for better understanding. 

Employees shall not have any other right except to right to exercise. ESOPs will give only two options to the employee to accept the ESOP or reject, there is no such right of renounce in favor of others.

The right to exercise will be available only after vesting the options in his favour.

5.6 Vesting period: Vesting means earns the right. In general vesting means to give an immediately secured right of present or future. 

The vesting period is the time that an employee must wait in order to be able to exercise ESOS. In Exercise of ESOS, where the employee notifies the company that he or she would like to buy the share, allows the employee to buy the referenced shares at the strike price indicated in the ESOS options intimation/ letter.

It is non-forfeitable right against the company. As per sub-rule 6 of the rule, there must be a minimum of waiting time of one year, however the company specify a period more than one year. 

In case of amalgamation and merger, the vesting period of ESOS elapsed at transferor company shall be taken into account while reckoning one year minimum vesting period.

5.7 Exercise of options: Exercise means to put into effect the right specified in a contract. 

For exercise of options, the employee has the right, but not the obligation, to subscribe or buy the underlying shares at a specified price on or before a specified date in the future. 

5.7.1 Exercise price: It is also known as strike-price. In general the strike price fixed by the seller of a security after receiving bids in a tender offer, typically for a sale of new securities or a new stock market issue. 

Exercise price for an option contract is a price at which a put or call option can be exercised. In case of ESOS exercise price is a pre-determined price at which the options granted can be purchased by the employee at a future date.

5.7.2 Freedom to fix of price: It should be noted as per the rule, the company is at liberty to fix the exercise price. 

However, such price shall be in conformity with applicable accounting policies of the company. 

5.8 Structures of ESOPs:

ESOPs typically are issued by the company directly or are done through the trust route. Each of the structures are explained below:

Direct Route:

In case of direct route, the company grants the option and at the time of exercise, fresh equity issuance is undertaken to allocate equity to the eligible employees. In case the employee decides to exercise the option, the employee also becomes the shareholder of the company.

Direct route is preferred by unlisted companies. The only issue with direct route structures is as and when the employee intends to monetize the shares, the company may have to buy-back the shares, specifically so in case of private limited companies or wait for the company to go for a public offering to get an exit from the company (as a shareholder).

Trust route brings in several complexities in the ESOP structures, the same are being discussed below.

Trust Route:

In the trust route structures, the company creates a trust specifically for the purpose of running the ESOP schemes. Where the employees decide to exercise the option to acquire the shares, the trust would first acquire the shares from the secondary market and the transfer the shares in the name of the employees.

Under the trust route, the company does not have to dilute its existing capital base and the structure is largely preferred by listed entities for secondary market acquisition of the shares.

These employee welfare trusts are funded by the company to acquire the shares in the secondary market to be transferred to the employees upon exercise of the options. In essence, the company is indirectly funding the acquisition of the shares of the company for the employees

When the employees leave the company, the employees have the option of selling back the shares to the trust or in the secondary market and monetizing the wealth creation by way of subscribing to the shares. The exit route is far easier in case of trust mechanism than in case of direct route structures.

In case of trust route of issuance of ESOPs, the trust on its own will not have funds to be able to acquire the shares from the secondary market as the trust is not a business trust and is a specifically created with the objective of issuance of ESOPs to the employees.

The Companies Act, 2013 facilitates the company to on-lend to the trust for it to acquire shares from the secondary market to be allocated to the employee shareholders.

Section 67 of Companies Act, 2013 read with Rule 16 of the Companies (Share Capital and Debentures) Rules, 2014 allows the unlisted public companies to make provisions of money involving purchase or subscription of its own shares or shares of the company subject to the fulfilment of the conditions specified below.

Conditions

      (1)    (a) the scheme of provision of money shall be separately passed by special resolution in a general meeting;

              (b) In case of listed Company, the Trust shall purchase the shares from the secondary market.

              (c) In case of unlisted Company, valuation of the shares purchased by the trust shall be done by an Independent Registered valuer.

              (d) the total value of shares in the trust shall not exceed 5%. of the aggregate of paid up capital and free reserves of the company;  

    (2)     The explanatory statement to be annexed to the notice of the general meeting to be convened pursuant to section 102 shall, in addition to the particulars                            mentioned in sub-rule (1) of rule 18, contain the following particulars, namely:-

 

                    (a) the class of employees for whose benefit the scheme is being implemented and money is being provided for purchase of or subscription to shares;

                    (b) the particulars of the trustee or employees in whose favor such shares are to be registered;

                    (c) the particulars of trust and name, address, occupation and nationality of trustees and their relationship with the promoters, directors or key managerial                              personnel, if any;

                    (d) the any interest of key managerial personnel, directors or promoters in such scheme or trust and effect thereof;

                    (e) the detailed particulars of benefits which will accrue to the employees from the implementation of the scheme;

                    (f) the details about who would exercise and how the voting rights in respect of the shares to be purchased or subscribed under the scheme would be                                     exercised;

    (3) If the voting rights are not exercised directly by the employees in respect of shares to which the scheme relates, the Board‟s Report shall disclose the following:

        o the names of the employees who have not exercised the voting rights directly and reason thereon;

        o the name of the person who is exercising such voting rights

        o the number of shares held by or in favour of, such employees and the percentage of such shares to the total paid up share capital of the company

        o the date of the general meeting in which such voting power was exercised;

        o the resolutions on which votes have been cast by persons holding such voting power;

        o the percentage of such voting power to the total voting power on each resolution;

        o whether the votes were cast in favour of or against the resolution.

Who cannot be trustees:

A person shall not be a trustee who:

# is a director, KMP or promoter of- 

o the company or

o its holding,

o subsidiary or

o associate company or

o any relative of such director, KMP or promoter; or

# beneficially holds 10% or more of the paid-up share capital of the company.

Conditions for secondary acquisition by Trust:

i) Limit on secondary acquisition for one financial year: Secondary acquisition in a financial year by the trust shall not exceed 2% of the paid up equity capital as at the end of the previous financial year. 

ii) Limit of total number of shares under secondary acquisition: The Trust cannot hold at any time total number of shares under secondary acquisition as mentioned below: 

Particulars	Limits on    the basis of the paid up equity capital as at the end of the financial year immediately prior to the year in which shareholders approval is obtained
For ESOS, ESPS & SARS	5%
For GEBS & RBS	2%
For all the schemes in aggregate	5%

Treatment of expanded capital in the aforesaid limit:

Any expansion taken place on account of corporate action shall automatically include within the limit aforesaid.

Multiple trusts and schemes:

The aforesaid ceiling limit shall be applicable for all such trusts and schemes taken together at the company level and not at the level of individual trust or scheme.

Shares issued by way of new issue or gift from promoter or promoter group or other shareholders:

The above ceiling limit calculated with respect to the percentage of paid up equity capital will not be applicable.

What if the aforesaid limits are exceeded?

Such shortfall of shares shall be made up by the company through new issue of shares to the trust in accordance with the provisions of new issue of shares under the applicable laws.

Unappropriated inventory of shares under ESOS, ESPS and SARS:

If the un-appropriated shares are not backed by grants, the same shall be appropriated within the end of the subsequent financial year. 

Lock in period for shares acquired through secondary acquisition:

The trust shall be required to hold the shares acquired through secondary acquisition for a minimum period of 6 months except off-market transfer of shares- 

     $ by participating in open offer under Takeovers Regulations, 2011; or 

     $ by participating in buy-back, delisting or any other exit offered by the company generally to its shareholders. 

Also, the Trust shall be eligible to make off market transfer to employees pursuant to the scheme subject to the lock in period as mentioned above. 

Restriction on sale of shares in secondary market:

The sale of the shares by the Trust in secondary market is not permitted except under the following circumstances- 

    @ cashless exercise of options under ESOS; 

    @ on vesting or exercise of appreciation rights under SARS; 

    @ in case of emergency for implementing the schemes under RBS and GEBS subject to the record of reasons for such sale by the trustees and money so realised on           sale of shares shall be utilised within a definite time period as stipulated under the scheme or trust deed.

    @ participation in buy-back or open offers or delisting offers or any other exit offered by the company generally to its shareholders, if required;

    @ for repaying the loan, if the un-appropriated inventory of shares held by the trust is not appropriated within the timeline as provided under sub-regulation (12) of             this regulation;

    @ winding up of the scheme(s); and

    @ based on approval granted by SEBI to an applicant, for the reasons recorded in writing in respect of ESOS, ESPS and SARS upon payment of a non-refundable

         fee of rupees 1 lakh along with the application.

Disclosures by the Trust:

The Trust is required to make disclosures and comply with the other requirements applicable to insiders or promoters under the SEBI (Prohibition of Insider Trading)

Regulations, 1992 or any modification or re-enactment thereto.

Variation in the terms of the scheme:

For variation of terms of the schemes already approved by an earlier resolution including repricing of options, SARs etc. can be made only with the approval of the shareholders by way of a fresh special resolution subject to the condition that such variation shall not be detrimental to the interests of the employees. The notice shall contain-

    o Full details of the variation,

    o The rationale therefore, and

    o The details of the employees who are beneficiaries of such variation.

Winding-up of the scheme implemented through Trust:

The company to meet all outstanding obligations and the excess money or shares remaining with the trust thereafter shall be utilised for repayment of loan or by way of distribution to employees as recommended by the compensation committee.

Schemes implemented prior to IPO:

If any shares arise out of options or SAR granted under any scheme prior to initial public offer to the employees after the initial public offering ('pre-IPO scheme‟) such shares shall be listed immediately upon exercise in all the recognised stock exchanges where the shares of the company are listed subject to compliance with the SEBI (ICDR) Regulations, 2009 and the following conditions:

    a. Any fresh grant which involves allotment or transfer of shares under any schemes formulated prior to its IPO and prior to the listing of its equity shares only if the

        scheme is-

                i. in conformity with these regulations; and 

                ii. ratified by its shareholders subsequent to the IPO at any time prior to grant of new options under such scheme.

    b. No change should have taken place in the terms of such schemes (except for any adjustments for corporate actions) unless prior approval of the shareholders is                taken for such a change.

Compliances to be observed:

A company will have to observe the applicable provisions of the Companies Act, 2013 and rules made thereunder, SEBI Act, 1992 and applicable guidelines, regulations made thereunder, these Regulations and any other applicable laws issued by various regulatory authorities for implementing any schemes related to employee benefits including-

1. Obtaining of in-principle approval of the stock exchanges.

2. Appointment of a registered merchant banker for the implementation of schemes covered by these regulations till the stage of obtaining in-principle approval from the stock exchanges.

3. If the company issues options etc. to the employee of its subsidiary, the cost incurred by the company shall be disclosed in the 'notes to accounts' of the financial statements of the subsidiary company. In case of re-imbursement, both the companies shall disclose in the notes of accounts.

4. The board of directors shall at each annual general meeting place before the shareholders a certificate from the auditors of the company that the scheme(s) has been

implemented in accordance with these regulations and in accordance with the resolution of the company in the general meeting.

5. The Board of Directors is required to disclose, in relation to employee benefits under the Companies Act, 2013 as specified by the SEBI Circular as follows:

    a. any material change in the scheme(s) and whether the scheme(s) is / are in compliance with the regulations;

    b. the web-link of the following disclosures disclosed on the website of the company:

            i. Relevant disclosures in terms of the 'Guidance note on accounting for employee share-based payments' issued by ICAI or any other relevant accounting                            standards as prescribed from time to time;

            ii. Diluted EPS on issue of shares pursuant to all the schemes in accordance with 'Accounting Standard 20 - Earnings Per Share' issued by ICAI or any other                         relevant accounting standards as prescribed from time to time;

            iii. Details related to each scheme;

            iv. Details related to Trust;

6. The company is to follow the 'Guidance Note on Accounting for employee share-based Payments' (Guidance Note) or Accounting Standards as may be prescribed by the Institute of Chartered Accountants of India (ICAI) from time to time, including the disclosure requirements prescribed therein.

7. The Option or SAR grantees are provided with the following details:

    a. Statement with respect to risk of value of shares, concentration, leverage, illiquidity etc;

    b. Information about the company;

    c. Salient features of the scheme.

8. Any new shares issued shall be listed immediately in any recognized stock exchange where the existing shares are listed, subject to the following conditions:

    a. Scheme is in compliance with these regulations;

    b. A statement as specified by SEBI Circular in this regard, is filed regarding-

         i. description of the scheme signed by the Company Secretary and the following documents to be filed along with the statement:

                    1. Copy of scheme, Copy of notice of AGM/EGM approving the scheme/for amending the scheme/for approving grants and Copy of resolution of                                         shareholders for approving the scheme/ for amending the scheme/for approving grants duly certified by the Company Secretary;

                    2. List of Promoters as defined under these Regulations;

                    3. Copy of latest Annual Report;

                    4. Certificate of Auditor on compliance with of the Regulations;

                    5. Specimen copy of share certificate.

        ii. an undertaking for compliances under these Regulations, SEBI(PIT) regulations etc.

        iii. a certificate with respect to meeting of requirements under these Regulations signed by the Compliance Officer;

        iv. a certificate from registered Merchant Banker.

    c. Has obtained an in-principle approval from the stock exchanges;

    d. Whenever an exercise is made, the company requires to notify the concerned stock exchange as per the statement specified by SEBI Circular in this regard

        signed by the Company Secretary or Compliance Officer as follows:

            i. Company name and address of Registered Office;

            ii. Name of the Stock Exchanges on which the company‟s shares are listed;

            iii. Filing date of the statement referred in point (a) above;

            iv. Filing Number, if any;

            v. Kind of security to be listed;

            vi. Par value of the shares;

            vii. Date of issue of shares;

            viii. Number of shares issued;

            ix. Title of the Scheme pursuant to which shares are issued, if any;

            x. Share Certificate No., if applicable;

            xi. Distinctive number of the share, if applicable;

            xii. ISIN Number of the shares if issued in Demat;

            xiii. Exercise price per share;

            xiv. Premium per share;

            xv. Total Issued shares after this issue;

            xvi. Total Issued share capital after this issue;

            xvii. Details of any lock-in on the shares;

            xviii. Date of expiry of lock-in;

            xix. Whether shares identical in all respects to existing shares if not, when will they become identical?

            xx. Details of listing fees, if payable.

Now again required to take the story to another level, to continue reading click here.