ESOPS
With special reference to start-ups with reference to Private Limited Companies Only.
Employee stock options are a great way to attract top talent while not burning a hole in your wallet which may or may not have much money given you are a start-up and are boot-strapped or have some seed money.
For company's who are funded or funds are not a constraint can always issue ESOPs to make the employees, the good ones, have their skin in the game and hence, like owners, be value and growth driven, like owners and with a sense of ownership.
3 key benefits are:
Ownership attitude, golden handcuffs - retention tool, no immediate high salary burn.
Let's understand the basics:
What are they?
A personal right to purchase shares at a future fixed date at a pre-determined price.
Let's study and analyse this one line in depth:
a) As it is a right, it is not compulsory for the employee to exercise that right but is an option.
b) This pre-determined price is called the exercise price, i.e. the price at which the employee will purchase the shares at the future date. Please note, the exercise price on the purchase date needs to be lower than the price prevailing in the market as on that date otherwise, the employee will not exercise his rights, it being then, a loss making proposition.
c) Future fixed date is the vesting period. As in, this is the period the employee needs to spend with the company to exercise his ESOP. Minimum period under law is 1 year.
d) Like the vesting period, there is also an exercise period. A period within which the employee needs to exercise his rights.
e) As it is a personal right, it is non-transferable or assignable.
Who can issue ESOP under law?
a) A permanent employee of the Company working in India or Abroad or
b) A director of the company but not to an independent director (duh!) or
c) A permanent employee of the holding or associate company. (Flows upwards. Downwards is not allowed)
Who is not eligible for ESOP?
a) Promoters
b) Any shareholder holding more than 10% either directly or indirectly.
Compliances?
a) Needs to be approved by the shareholders. Simple majority will do.
b) Progress of the ESOP scheme needs to be updated by the Board (the directors) through the annual return and director's report.
c) ESOP register to be maintained and updated containing all employee and stock particulars.
All in all, it's a beautiful win-win tool if structured well taking into account the needs of the promoters and the employee.
How does taxation work?
At the time of granting or giving:
a) Treated as perquisite in the hands of employee.
b) Employer needs to deduct TDS.
c) Perquisite value is the difference between fair market price and exercise price.
d) When the employee sells, it will be taxed under capital gains. Presently only short-term capital gains are taxed at 15% and short term is defined as 12 months.
Why do companies offer ESOPs to their employees?
Companies offer ESOPs to attract and retain talented employees. They distribute stocks gradually to reward loyalty and incentivize employees to stay with the company. ESOPs make employees stakeholders in the company, fostering a sense of ownership. Start-ups, facing cash constraints, use ESOPs to offer competitive compensation packages and attract talent.
The author can also be reached at kunal@whitecollarlegal.in
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