Introduction to ESOPs in Indian Companies
As you know, ESOPs serve as a boon to Indian companies, especially startups. There are mainly two aspects the said unlisted company has to look at:
1. The provisions of the Companies Act, and
2. The Memorandum & Articles of the company.
The Companies Act, 2013
The Companies Act, 2013 (the "Act") and Rule 12 of the (Share Capital and Debentures) Rules, 2014 (the "Rules") prescribe the provisions for the issue of Employee Stock Options by unlisted private limited companies.
As per Section 62(1)(b) of the Act, an unlisted private limited company can issue further shares to employees under a scheme of Employees' Stock Option ("ESOPs"), pursuant to a special resolution. The company has to follow the procedure prescribed under the Rules.
"Employees' stock option" is defined under Section 2(37) of the Act as: "option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price."
Rule 12 of the (Share Capital and Debentures) Rules, 2014
Under the said Rules, ESOPs can be issued only to the "employees" of an unlisted private limited company.
Rule 12(1) defines "Employee" as:
a) a permanent employee of the company who has been working in India or outside India; or
b) a director of the company, whether a whole-time director or not but excluding an independent director; or
c) an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company or of an associate company.
As per Rule 12(c), the following are not included in the definition of an Employee, and therefore, ESOPs cannot be issued to the following:
- an employee who is a promoter or a person belonging to the promoter group; or
- a director who either himself or through his relative or through anybody corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.
However, the above conditions provided in Rule 12(c) are not applicable to a startup company for a period of 5 years from the date of its incorporation or registration.
Requirements for ESOP Scheme Approval
Once a private limited company identifies employees who are eligible to avail benefits under the ESOP Scheme, the company is required to comply with the following requirements:
- The Employees Stock Option Scheme needs to be approved by the shareholders of the company by passing a special resolution.
- The company is required to make the following disclosures, in the explanatory statement annexed to the notice for passing the resolution:
- The total number of stock options to be granted;
- Identification of classes of employees entitled to participate in the Employees Stock Option Scheme;
- The appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;
- The requirements of vesting and period of vesting;
- The maximum period within which the options shall be vested;
- The exercise price or the formula for arriving at the same;
- The exercise period and process of exercise;
- The lock-in period, if any;
- The maximum number of options to be granted per employee and in aggregate;
- The method that the company shall use to value its options;
- The conditions under which options vested in employees may lapse, e.g., in case of termination of employment for misconduct;
- The specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of the employee; and a statement to the effect that the company shall comply with the applicable accounting standards.
The companies granting options to their employees pursuant to ESOPs Scheme can determine the exercise price in conformity with the applicable accounting policies, if any.
The approval of shareholders by way of separate resolution needs to be obtained by the company in case of:
- Grant of options to employees of a subsidiary or holding company; or
- Grant of options to identified employees, during any 1 year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.
The company may, by special resolution, vary the terms of ESOPs Scheme not yet exercised by the employees, provided such variation is not prejudicial to the interests of the option holders. The notice for passing a special resolution for the variation of terms of ESOP Scheme shall disclose the full variation, the rationale therefor, and the details of the employees who are beneficiaries of such variation.
- Minimum period of 1 year between the grant of options and vesting of the option.
- The company can specify the lock-in period for the shares issued pursuant to the exercise of the option.
- The employees shall not have the right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of the option granted to them until shares are issued on the exercise of the option.
The amount, if any, payable by the employees, at the time of the grant of the option:
- May be forfeited by the company if the option is not exercised by the employees within the exercise period; or
- The amount may be refunded to the employees if the options are not vested due to non-fulfilment of conditions relating to vesting of the option as per the ESOP Scheme.
- The option granted to employees is not transferable to any other person.
- The option granted to the employees shall not be pledged, hypothecated, mortgaged, or otherwise encumbered or alienated in any other manner.
- Subject to clause (d), no person other than the employees to whom the option is granted shall be entitled to exercise the option.
- In the event of the death of an employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.
- In case the employee suffers a permanent incapacity while in employment, all the options granted to him as of the date of permanent incapacitation shall vest in him on that day.
- In the event of resignation or termination of employment, all options not vested in the employee as of that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the board of directors of the company.
The board of directors of the company shall, inter alia, disclose in the Directors' Report for the year the following details such as (i) the options granted, vested, exercised, and lapsed, (ii) the total number of shares arising as a result of the exercise of options (iii) the exercise price, (iv) variation of terms of options, (v) money realized by the exercise of options, (vi) the total number of options in force, and (vii) employee-wise details of options granted to the key managerial personnel, any other employees, and identified employees.
Compliances
In addition to the above requirements, the company is required to comply with the following compliances as per Rule 12(10) of the Rules:
- Maintain a Register of Employee Stock Options in Form No. SH.6 and shall enter the particulars of options granted under Section 62(1)(b) of the Act.
- The Register of Employee Stock Options shall be maintained at the registered office of the company or such other place as the board of directors of the company may decide.
- The entries in the register shall be authenticated by the Company Secretary of the company or by any other person authorized by the Board of Directors for this purpose.
Please note this post is intended to provide general information on the subject matter. Specialist advice should be sought about your specific circumstances. You are better advised by your Company Secretary and Statutory Auditors who are supposed to be guided by the Directors on your Board.