Companies manage and hire top talent with ESOP (Employee Stock Option Plan)!

It is an employee benefits scheme under which the company encourages the employees to acquire ownership in the form of shares at a predetermined rate. Usually, companies issue ESOP to employees to make them stay with their organization for a long time. It motivates the employees to perform better and offer their loyalty to the company.

Suppose an employee receives 400 shares. On completion of every 1 year, 100 shares will be vested. The valuation of the shares increases with the valuation of the company. This also keeps a check on the attrition rate.

Why should we use ESOP?

  • ESOPs are a tax-favored strategy that delivers fair value for shareholders.
  • Employee Stock Option Plan allows for a “low and slow” ownership transition.
  • ESOPs benefit the people who play a constructive role and remain in the company for a long time
  • It creates tax-favored independent and sustainable companies.
  • The Employee Stock Option Plan creates and preserves a legacy.

Key Benefits of Employee Stock Option Plan

Attract Top Talent: You may not be able to match their current salary, but an offer of shares in your company will be enough to attract the best talent.

Build Motivation: The better your business performs, the better your most talented employees will get paid. There’s no better way to motivate them.

Keep Them Longer: The employees to whom shares have been allocated are almost certain to complete the four to five years you have defined as vesting period.

Checklist/ requirement for Employee Stock Option Plan

  • Check the articles for any specific provision on the issue of share under ESOP.
  • The date and members of the compensation committee should be included in the board meeting.
  • Notice of general meeting including the number of ESOP to be granted.
  • Likewise, hold a general meeting for approval of shareholders by way of ordinary resolution. Additionally, include the authorization for the issue of shares under ESOP and the formation of the compensation committee.
  • There must be a compensation committee (CC). The CC shall be a committee of board directors consisting of a majority of independent directors.
  • Approval of shareholders by separate resolution.
  • The requirement of a draft copy of certificates.
  • Filing of Form-PAS-3.
  • Disclosure in Director Report (DR).
  • Maintenance of register of ESOP in SH-6 at the registered office of the company or such other place as the board may decide.
  • Entities in the register shall be authenticated by CS or any other person authorized by the board.

Who is eligible for ESOP?

According to the IRS (Indian Revenue Service), the maximum age an employer can impose to be eligible for an ESOP is 21. Moreover, he/she must be eligible for ESOP in the year of joining the company. An employer can restrict eligibility to employees with two years of service but only if the plan has immediate vesting.

How to structure an Employee Stock Option Plan

  • Determine whether other owners are amenable.
  • Conduct a feasibility study.
  • Conduct a valuation.
  • Hire an ESOP attorney.
  • Obtain funding for the plan.
  • Establish a process to operate the plan.

How to register an Employee Stock Option Plan

Draft The ESOP Rules

Your ESOP rules set out the terms that apply to all options granted under the plan, including the process for granting options, how and when employees can exercise their options, and what happens to the options on an exit event, or if an employee leaves. The document will include the following schedules:

  • Schedule 1: A grant letter setting out the terms of the options you want to grant to recipients.
  • Schedule 2: The form of the exercise notice to be delivered to the company when an option holder wants to exercise their vested options.
  • Schedule 2: The form of the exercise notice to be delivered to the company when an option holder wants to exercise their vested options.
  • Schedule 3: An option certificate which records the number of options, exercise price and vesting provisions.

Approve The Rules And The Option Pool

Once you are satisfied with the ESOP rules, your directors and shareholders will need to sign some corporate approval documents to adopt the ESOP rules and set up your option pool.

Board And Shareholder Approval

There are some resolutions which include:

  • The approval of the Employee Stock Option Plan rules.
  • The total number of options in the ESOP pool.
  • Authorization for the board to grant options to recipients of their choosing, and
  • Authorization to issue shares on any exercise of the options.

Shareholder Waivers And Consents

Your constitution and shareholder’s agreement may include pre-emptive rights on the issue of new shares. If this is the case, these shareholders with preemptive rights will need to sign a waiver in respect of any options granted the ESOP.

Grant your options

Prepare Your Directors’ Resolutions: Each time you want to grant options, you should ask your corporate secretary to prepare a new set of directors resolutions in writing, approving the grant of options to a specific recipient.

Send Each Recipient Their Grant Letter: Once you have received the letter, you can issue them their option certificate. You can find the option as the certificate form in schedule 3. Here the schedule should be left blank and a separate option certificate provided to the recipient. That is, you need to create a fresh, separate word doc.

Update Your Register Option: Internally, you should also be keeping an option register, which is a record of all the options the company has granted, the vesting schedules, expiry dates, and exercise dates.

Documents required for Employee Stock Option Plan

  • Minutes of a board meeting.
  • Special resolution approving ESOP along with the explanatory statement.
  • Minutes of the general meeting.
  • Boards report.
  • Register of employee’s stock option plan.
  • PAS- 3, MGT- 14.

FAQs on ESOP

Can a private company issue an ESOP?

Yes, the private limited company can approve ESOP to its employees subject to the limitation of the maximum number of shareholders.

What happens to an ESOP when the company is sold?

Usually, when a company is sold, the ESOP will terminate and the employee-owners receive cash proceeds for their company stock. In some cases, your company may be sold to a company with its own ESOP. Normally, this happens in a rollover of some or all of your ESOP shares into the shares of the new company ESOP.

Is ESOP good for employees?

Being a member of an ESOP company, it can provide unique rewards for employees. Participants in the plan can get significant retirement benefits at no monetary cost to them. Also, an ESOP is an excellent way to enhance the company’s ability to recruit and retain top talent.