Understand Employee Stock Option Plan under the Companies Act 2013 in a Nutshell

If you are an employee of an organisation that is going to issue their employees the stocks then you must be wondering as to what is the eligibility criteria, how you can obtain such stocks and so on. For resolving all of your doubts related to this we have got you covered, so let’s move further!

Introduction to the Employee Stock Option Plan

The Employee Stock Option Plan popularly known as ESOP is an employee benefit plan and is issued by an organisation to its employees to encourage employee ownership in the organisation. In this benefit program, the shares are issued to the employees at a discount. Organisations other than the listed companies are required to issue the ESOPs in accordance with the provisions specified under the Companies Act, 2013 and the Companies (Share Capital and Debenture Rules), 2014 but in the case of the listed companies these shares are required to be issued in accordance with the guidelines prescribed by the Securities and Exchange Board of India Employees Stock Option Scheme guidelines.

ESOPs have been defined under Section 2(37) of the Companies Act, 2013 as the option issued to the employees, officers, or directors of the company or the holding or subsidiary of the parent company to purchase or subscribe to their issue of such shares on a future date at a predetermined price. 

With the help of this scheme, the company proposes to increase its subscribed share capital with the issue of further shares to its employees. Thus, it can be summed up that this scheme not only benefits the employees but to the issuing organisation.

Key Terms to Understand ESOPs in Detail

• Grant: The main important terminology in the issuing of shares is the grant of the stocks to the employee. Grant in simple terms stands for the issuance of the shares. It is about informing the employees that they are eligible to hold the ESOPs and the company has the power to determine the exercise price at the time of providing the option of the ESOP to their employees.

• Vesting: Vesting is the right of the employees to apply for the shares granted to them by the organisation. The lock-in period for the employees shall be one year between the grant of the option and the vesting of the option.

• Exercising: As we have pointed out the vesting period for the ESOPs is the year and the exercising option is where the option holder can exercise their option of buying the shares though the lock-in period is at the discretion of the company after the employee exercises their option and in such a case the employees will not have the right to vote, enjoy any advantages of a shareholder, or receive any dividends until the shares are issued upon exercise.

• Option Pool: This is usually used by start-ups before issuing ESOPs. In this option pool, a set of shares is created for their early employees whereas founders also use the option pool to attract the top talent from the industry towards their organisation in the cases where they are yet to generate the decent revenue to offer competitive compensation packages to the hired top talent.

• Strike Price: It is the rate at which the employees can purchase the stocks granted

• Expiration Date: As soon as the company announces the grant the employees are required to exercise their rights and then purchase the shares allocated within the specified period and if the employee fails to exercise this option the ESOP in such a case will expire.

What are the Eligibility Criteria for the issue of the ESOPs?

Rule 12(1) of the Companies (Share Capital and Debenture Rules), 2014 states the eligibility criteria for the issue of the ESOPs and these are as:

• The director of the company includes a part-time and full-time director but excludes an independent director

• A permanent employee of the company working in India or outside India.

• A permanent employee or a director of a subsidiary company, associate company or holding company working in India or outside India

• If the issuing company is a private company then it is required that the articles of association of such a company must authorise the issuance of the shares through ESOPs. But if the articles of association do not authorise the issuance of the shares through ESOPs then the company is required firstly to hold an extraordinary general meeting to alter the article of association to include a provision for the issuance of the shares through ESOPsand then a board meeting is also required to be held for the passing of such a resolution and detaining the approval from the shareholders.

ESOPs cannot be issued to whom?

• A director who either by himself or through his relatives or through any body corporate holds more than 10% of the outstanding equity shares of the company either directly or indirectly.

• If an employee who either belongs to the promoter group or is a promoter of the company

• The above-mentioned conditions are not applicable to the start-up to start-up companies for a period of 10 years from the date of its incorporation.

What is the Process of issuing the ESOP?

Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debenture Rules), 2014 governs the issuance of the ESOP to the employees. The procedure for the issuance of the ESOP is similar to that applicable to the grant of the ESOP for listed companies governed by the Securities and Exchange Board of India Employee Stock Option Scheme guidelines. The process runs as under:

• Preparing the Draft: The draft for the ESOP is required to be drafted in accordance with the Companies Act and the Companies (Share Capital and Debenture Rules), 2014

• Preparing Notice: After drafting the ESOP a notice of the board meeting is required to be served upon the directors by giving at least seven days’ notice before the meeting.

• Passing of the Resolution: A resolution for the issuance of the ESOPs is required to be passed in the board meeting. the resolution must determine the price of the shares to be issued, time, date and lastly approving the calling of the general meeting for the issuance of the ESOP.

• Preparing the Minutes of the Meeting: The minutes of the board meeting are required to be sent to all the directors within 15 days of the conclusion of the meeting and an MGT-14 form for the passing of the board resolution is also required to be submitted with the registrar of the companies

• Sending notice of the General Meeting: A notice of the general meeting is required to be served upon the shareholders, directors, auditors, and secretarial auditors of the company at least 21 days before the date of the general meeting.

• Passing the Special Resolution: The special resolution is required to be passed in the general meeting for the issuance of the shares under the ESOP to the directors, officers and employees of the company.

• Filing MGT-14: An MGT-14 Form is required to be submitted within 30 days with the registrar of the companies of the passing of the special resolution for the issuance of the shares under the ESOP to the directors, officers and the employees of the company in the general meeting.

• Purchase of the Shares: The options are required to be sent to the directors, officers and employees of the company for purchasing the share under the ESOP.

• Maintaining the Register of ESOP: The company is required to maintain a register of the ESOP in form No.SH .6 and thereby entering the particulars of ESOPs granted to the officers, directors or the employees of the company.

What are the statutory requirements for the issuance of ESOPs under the Companies Act, 2013

• Section 2(37): This Section defines the employee stock options provided to the offices, directors, or the employee. However, the Act is silent on treating Employee Benefit Schemes such as Phantom Stock or Stock Appreciation Rights.

• Section 62(1)(b): This Section governs the issuance of the ESOPs to the employees. An ESOP is issued when the company passes a special resolution and fulfills the terms and conditions associated with the ESOP.

• Rule 12 of the Companies (Share Capital and Debenture Rules), 2014: This Rule lays the requirement for the passing of the special resolution and which must contain the below:

• The number of stocks to be granted
• The manner of the identification of the employee
• The vesting requirements of the ESOP
• Any lock-in period
• The methodology of the valuation
• The conditions for reverse vesting

What are the Specific Requirements for the Listed Companies for the issuance of ESOPs?

As we have rightly pointed out apart from the requirements specified by the Companies Act, 2013 the listed companies are also required to follow the SEBI (Share-Based Employees Benefits) Regulations, 2014 and these are as:

• The company is required to transfer the option pool to the trust and then provide the financial assistance to the trust

• The ESOP can be implemented by the company or a trust which is also known as the ESOP trust

• Lastly, all the listed companies are required to form a Compensation Committee and this Committee will determine the eligibility criteria and the terms and conditions associated with the options.

What are the Disclosures to be made in the Board Report while issuing the ESOP?

The directors of the company are required to prepare a board report which should disclosure the following:

• The number of stocks to be issued

• The identified class of officers, directors and employees who are eligible for the ESOP

• The requirements of the Vesting Period

• The maximum period within which the options are required to be vested.

• The prices and the period of the exercise of the stocks.

• The lock-in period

• Granting the maximum number of options

• The methods for the valuation of the stocks of the company

• The conditions of the lapse of the options

• Lastly, a statement that the company needs to comply with the applicable accounting standards.

Tax Implication of the ESOPs

ESOPs provide Taxation benefits to the company as well as the employee. The company for this can claim a deduction on tax towards the employee benefit expense under Section 37 of the Income Tax Act, 1961 while the employees are taxed on the prerequisite amount being the difference between the exercise price and the fair market value of the shares at the time of exercise of the shares.

How is the Administration and Governance of the Employee Stock Option Plan work?

The regime of the administration and the governance of an ESOP includes managing the operations of the Plan ensuring regulatory and legal compliances and lastly managing any ESOP trust that has been established. A trustee or a committee is established with a view to keeping the records, handling distributions and ensuring that the ESOP works in the best possible manner because the effectiveness of the ESOP is important for the success and the stability of the Scheme.  

Conclusion

An ESOP is a benefit scheme where the shares of the company, or its subsidiary company are issued by the organisation to their offices, employees or directors at a discounted rate. The persons can enjoy the benefits of the ESOPs only after the completion of the lock-in period.

Frequently Asked Questions on Employee Stock Option Plan Under Companies Act 2013

Q 1. What is ESOP under the Companies Act, 2013?

Ans 1. ESOP is a scheme that grants employees the right to acquire shares in a company with an ownership interest.

Q 2. What is Section 62 of the Companies Act, 2013?

Ans 2. Section 62 states that if a company decides to issue the fresh shares then these should be offered first to the existing shareholders who will be the holders of the equity shares.

Q 3. What are the guidelines regarding ESOPs?

Ans 3. The main guidelines regarding the ESOPs are the requirements related to disclosure and reporting

Q 4. Who is eligible for ESOP?

Ans 4. Every employee of the organisation is eligible for ESOP except the directors and the promoters who hold more than 10 % equity.

Q 5. What is ESOPs salary?

Ans 5. It is an employee benefit program that offers employees ownership interest in the form of equity shares.

Q 6. What is the maximum limit of ESOP?

Ans 6. An overall limit of 5% is the maximum limit of the paid-up equity capital.

Q 7. What is the maximin vesting period for ESOP under the Companies Act, 2013?

Ans 7. One year is the maximum vesting period for the ESOP.

Q 8. What is the ESOP 10-year Rule?

Ans 8. An employee after completing 10 years and reaching the age of 55 gets an option to either cash the ESOP or stock distribution for diversification.

Q 9. What is the lock-in period for ESOP?

Ans 9. The lock-in period for ESOP is the minimum duration for which an employee is required to wait to exercise their options.

Q 10. Is ESOP part of CTC?

Ans 10. Yes, ESOPs are part of the CTC.