All About Employee Stock Option Plan (ESOP)

Background

Employee Stock Option Plan (Hereinafter "ESOP") or Equity incentive plan is the scheme through which the companies provide ownership rights to its employees.

ESOP is governed through Section 62(1) (b) of the Companies Act, 2013 ("CA, 2013") and SEBI (ESOS and ESPS) Guidelines, 1999 as amended.

In the present article, understanding with regard to the ESOP scheme has been provided.

Understanding ESOP?

In simple words, under the ESOP scheme, the Company provides ownership stake to its employees. It is one of the methods through which the Companies attracts its employee not to leave the jobs, it can also be said that it is the retention of employees mechanism. Well this is optional for the employee meaning thereby not obligatory to take it. The employee may decide whether to opt for the scheme or not. Under the ESOP scheme, whole-time directors of the Company or permanent employees of the Company benefited with the right of purchase of shares of the Company at some predetermined price.

Benefits

The employees got motivated and stay intact as their stakes are also involved.

• A replacement of cash.
• Ownership provided to employees.

Definition of Employee?

• An employee can be a person who is:-
• A permanent employee of that organization.
• A director of that organization.
• Employees of a subsidiary of that Company.

However, employees do not include, Any employee(s) who was or is a promoter or an employee(s) of the promoter group. Further, any director who (directly or indirectly ) owned more than 10% of the equity shares of the organization.

The ESOP scheme can be provided by the Company through two ways:

a. Equity Route
b. Trust Route

Let's learn about Equity Route, in Equity Route, the equity shares are being issued to existing employees when they exercise this option.

Trust Route

Under this route, an Employee Welfare Trust is being formed by the Company for the administration of ESOP. Company issue scrips to this trust which ultimately transferred to the employee whenever they exercise this option.

Procedure to be followed in order to formulate ESOPs through the equity route:

Step 1- The first step involved is to Constitute a Compensation committee.

Provisions with regard to the formation of the Compensation Committee are contained under Section 5 of the aforesaid guidelines. It is to be formulated by the Board of Directors of the Company having Independent directors in the majority. The committee is responsible for the formulation of rules and regulations of ESOP.

Step 2- Preparation of Plan

After that, the Compensation Committee shall form a plan in accordance with the guidelines as notified.

Step 3- Approval form the Board

Once the plan is prepared, the compensation committee shall take the approval from the Board and in case the said Company is listed, the said plan shall also requiring permission from the stock exchange as well.

Step 4- Approval of Shareholders

A special resolution shall be required to take approval form the shareholder of the Company. 3/4 of the shareholders shall approve the said plan.

Lock-in period

The maximum period is 1 year and employees cannot enjoy such benefits as of shareholders until the option is exercised.

Transferability of shares

It is to be noted that the shares given under this scheme are not transferable. In case of death of an employee(s) the shares shall be transferred to his/her legal heir or his/her nominee. It is to be noted that all right under the scheme shall be taken back in case of resignation or termination of the employee. The time frame within which the option of ESOP should be exercise shall be mentioned in the approved plan

Valuation

Basically, there are two methods that can be used in the valuation.

a. Fair value method
b. Intrinsic value method

It is optional for the companies to decide the method to be choose from and the same shall be disclosed in general meeting.