Startup's Need: Employee Stock Option Plan

Published on 15 Oct 2016 by Team

Employee Stock Options (ESOPs) were never as famous as today, thanks to the start-up culture. Earlier ESOP were given only to the senior employees as a remuneration for their contributions to the company. But today, to attract and retain employees and key managerial persons’ start-ups are giving ESOPs at a very early stage in order to compensate for the low salary. ESOPs are an excellent tool for succession planning, both for liquidity and transition. In addition to various tax benefits, ESOPs also allow business owners to reward their employees and managers with a stake in the business.

Benefit for Employers

An employee stock ownership plan is a kind of benefit which is given to the employee by the employer company. It is an equity based deferred compensation plan. Under these plans, the employer gives certain stocks of the company to the employee for negligible or fewer costs which remain in the ESOP trust fund, until the options vests and the employee exercise them or the employee leaves/retires from the company or institution. Talk to the best startup lawyers in India to get your ESOP policy laid down.

Benefits of ESOP for Startup

The benefit for startup’s by giving ESOP’s is to retain employees as there is a lock in period for exercising the right to purchase the shares. Along with it, it also gives employees the feeling of ownership. They start feeling that they are not employees of the organisation but owners. Also, they get to share the profits of the company in the form of dividends and are motivated to work for the best of the company. It is also an Option in lieu of salary, start up's that needs funds and are not in a position to spend hefty amounts can offer this option to their employees in lieu of salary and motivate them to work for the betterment of the company. Top startup advocates in India can help you with your ESOPS.

The Companies (Share Capital & Debenture) Rules, 2014

The said rules provide for relaxation for Start-ups, as they have been expressly permitted to issue ESOPs to their promoters and to directors who held more than 10% of the Start-up's equity shares for the first 5 years from the date of their incorporation whereas other companies are not permitted to do so.

A start-up cannot just grant options by issuing a simple letter to its employees. It has to follow the proper procedure under the law. It has to draft ESOPs scheme and get it approved at a shareholders meeting. After it has to issue a letter of the grant to the employee informing him how many options are being granted to him and vesting period. And if an employee wishes to exercise any of his vested options, he should make an Exercise Application to his employer company pursuant to which his options would be converted into equity.

What are terms or actions associated with ESOPs?

Granting of ESOPs, Vesting, Exercising and selling are the actions associated with Employee Stock Options (ESOPs).

  • Grant is a process by which an employee is given an option. It is the delivering of the options to the employee. The grant shall specify the number of options given, the time of vesting, etc
  • Vesting is a process whereby the employee acquires the right to exercise the options
  • Exercising: The activity of converting the options granted to employee into shares by paying the required exercise price is known as the exercise of options. It is like buying shares.
  • Selling: It is selling shares like normal shares.

In most companies in India, options vest for a period of 3-4 years from the date of grant of options and can be exercised anytime within a period of 2-5 years from the date of each vesting. ESOPs are structured in a way that they are exercised over three-five years. This is to ensure that the employees remain with the company for a longer period.

Alternatives to ESOPs are Restricted Stock Units (RSU), Employee Stock Purchase Plan (ESPP), Stock Appreciation Rights Plan (SAR).

Restricted Stock Units (RSUs)

Recently, there has been a growing trend of rewarding employees with Restricted Stock Units/ shares (RSUs). Restricted Stock Units represent an unsecured promise,i.e no strings attached, by the employer to grant an employee a set number of shares (at zero strike price) on completion of the vesting schedule or other conditions.

We can conclude that ESOPs are a great incentive for employees to put their heart and soul into an organisation. However, grant of options in itself does not mean that the employee will walk out of that organisation with millions in his bank account and employees should be conscious of this fact. Failure to understand the intricacies is likely to leave you highly disappointed when you resign to move on to your next job. 

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