Overview Of Employee Stock Option Plan

Introduction

An Employee Stock Option Plan (ESOP) is a type of benefit plan that provides employees with the opportunity to own a stake in the company they work for. In this type of plan, employees are given the option to purchase shares of their employer’s stock at a set price, also known as the grant price or exercise price. The options are granted over a period of time and employees typically exercise the options when the market price of the stock is higher than the grant price, allowing them to make a profit. ESOPs are a way for companies to reward and retain employees, aligning their interests with the success of the company. By giving employees a stake in the company, ESOPs can also help companies attract and retain top talent.

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The terms of an ESOP are set by the company and can vary greatly. Some companies may offer a fixed number of options to employees, while others may offer a percentage of total shares. Some plans may provide options to all employees, while others may only be available to senior executives. The length of time that options are granted, the vesting schedule, and the exercise price are also determined by the company.

The right provided to directors, employees, or officers of a business or its holding or subsidiary company to acquire, gain from, or subscribe to such firm’s shares at a specified price at a future period is described in Section 2(37) of “the Companies Act, 2013.”

As a result, an ESOP is a plan in which a firm seeks to enhance its authorized share capital by providing more shares to its employees at a set rate.

Employee stock ownership plans (ESOPs) benefit both the corporation and its employees. Employees can be rewarded once the company becomes public, which promotes startups. If they meet the conditions, every employee of the company could be granted an ESOP.

Issuance Of Esop

ESOPs can be granted to the following employees, according to Rule 12(1) of the Companies (Share Capital and Debentures) Rules, 2014.

• A corporate employee who works in India or abroad permanently.
• A company director is either full-time or part-time, but it is not an individual director.
• In India or elsewhere, a permanent employee or director of such a subsidiary, holding company, or associate firm.

The following employees are not eligible for an ESOP:

• An employee who seems to be a member of the promoter group or a firm promoter.
• A director who, indirectly or directly, owns more than 10 per cent of a company’s authorized equity shares, whether directly or indirectly through a corporation or a relative.
• However, for the first ten years after their incorporation, the aforementioned two restrictions don’t really applicable to Startup Companies.

Allotment Of Esop

The timing of distributing shares to employees through an ESOP is largely concerned with three primary aspects. The following are the details:

1. Grant: The distribution of shares to employees is referred to as a “grant.” It requires notifying the employee that he or she is eligible for an ESOP. Employees will also have the option of engaging in an ESOP, but the business will have total control over the exercise price.
2. Vest: Employees’ entitlement to claim shares that have already been granted to them. Between the issuing of an option and the exercising of an option under the ESOP scheme, there has to be a minimum of one year between both the issuance of an option and the exercising of an option.
3. Exercise: During the exercise period, employees have the choice to exercise their stock options. After the option is exercised, the company will have total control over the lock-in period for just any shares issued (if any). Employees would not have been able to collect a dividend, vote, or enjoy all the benefits of being a stakeholder in the ESOP until their option was exercised and the shares were allocated.

Advantages Of Esop

Because there is a lock-in period for executing the right to purchase shares, ESOPs might be considered a retainership mechanism for small firms. As a result, a company can keep its staff. If an employee chooses this option, he must first complete the lock-in term before being allowed to exercise it. Employees are given shares in the company where they work, which gives them a sense of ownership. They begin to believe that they are not employees, but rather owners of the company. They also receive a piece of the company’s income in the form of dividends, which motivates them to work hard for the company’s success.

“Businesses who require funds but are unable to spend large sums of money can provide this option to their staff in lieu of a pay to encourage them to work for the company’s benefit. It’s a non-cash incentive for companies to compete for the top employees. It allows corporations to pay without incurring a loss in book profits. Employee morale has improved.”

Criticism

Employee Stock Option Plans (ESOPs) have been widely used by companies as a way to attract and retain employees, align their interests with those of the company, and provide a mechanism for employees to share in the company’s success. However, ESOPs have also been criticized for several reasons:

1. Limited Access: ESOPs are often only available to a limited number of employees, typically those at the executive and senior management levels, leaving out a large portion of the workforce. This can lead to resentment and a sense of inequality among employees.
2. Complexity: ESOPs is a process which is very difficult to understand and can lead to confusion and a lack of trust in the plan.
3. Volatility: The value of an ESOP is dependent on the performance of the company’s stock, which can be volatile and subject to market conditions. This can result in employees being disappointed when the value of their options does not increase as expected or even decreases.
4. Diversion of Funds: Some critics argue that ESOPs divert resources away from other important company initiatives, such as research and development or investments in new technologies, that could be used to drive long-term growth.
5. Encouragement of Short-Term Thinking: Some argue that ESOPs can encourage employees to focus on short-term goals.
6. Legal Risks: ESOPs can also expose a company to legal risks, such as lawsuits related to the administration of the plan, compliance with tax and securities laws, and disputes over the value of the options.

Conclusion

ESOPs are a great way for startups to recruit and maintain employees, but they’re also a risk for employees. Employees should have been persuaded of the company’s future growth, and suitable paperwork must be in place. In India, the IT industry, such as Infosys, was the first one to implement the ESOP feature. Almost every industry now uses this strategy to hire and maintain top individuals.

Startup organizations are increasingly utilizing employee stock ownership plans (ESOPs) to attract top talent and prevent brain drain. Many startups struggle because competent and experienced people are hard to come by, and startup companies didn’t have to provide them with higher salaries as MNCs can. The only way for startups to keep and entice employees is to adopt an employee stock ownership plan (ESOP), which allows employees to sense ownership and contribute to the company’s growth and development.

Author: K.Srivalli Vaishnavi, in case of any queries please contact/write back to us at support@ipandlegalfilings.com or   IP & Legal Filing.

REFERENCES

Dhaval Gusani, Employee Stock Option Plan – Meaning, Benefits and Process, (22 Jun 2019), https://taxguru.in/corporate-law/employee-stock-option-plan-meaning-benefits-process.html.

ELVIS PICARDO, Employee Stock Option (ESO), (Updated April 23, 2022), https://www.investopedia.com/terms/e/eso.asp.

Exit Planning Solutions, https://exitplanning.com/blog/esops-good-bad-and-ugly.

Vantage Circle, https://blog.vantagecircle.com/esop/.