Issue of ESOP's and Its Procedure

Meaning (Section 2(37) of Companies act, 2013):

• “Employees’ Stock Option” means the 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.
• Employees’ Stock Option Scheme helps a company to enter into a strategic and robust relationship with their employees on a voluntary basis and in a gracious manner for their genuine benefit. It has now been accepted internationally that stock options are an effective instrument to align the interest of the employee with that of the company. It also provides an opportunity to employees to participate in the growth of the company, besides creating long term wealth in their hands.
• Section 62(1)(b) provides that a company may, at any time, issue shares to its employees under a scheme of employees’ stock option, subject to special / ordinary resolution in the case of a public / private company respectively passed by company and subject to such conditions as may be prescribed -

1. An employee stock ownership plan gives workers ownership interest in the company.
2. ESOP is usually formed to allow employees the opportunity to buy stock in a closely held company to facilitate succession planning.
3. ESOPs encourage employees to do what's best for shareholders since the employees themselves are shareholders and provide companies with tax benefits, thus incentivizing owners to offer them to employees.
4. Companies typically tie distributions from the plan to vesting.

• Employee shall have the same meaning as defined in clause (b) of sub-section (1) of section 62 and Rule 12 of the Companies (Share Capital and Debentures Rules 2014). ‘‘Employee’’ therefore means-

1. A permanent employee of the company who has been working in India or outside India; or
2. A director of the company, whether a whole time director or not but excluding an independent director; or
3. 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 but does not include: 

(a) An employee who is a promoter or a person belonging to the promoter group; or

(b) A director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

Routes of Esops

There are two routes available to companies for the creation and implementation of an ESOP:

• Direct Route; and                             
• Creation of a Trust

Direct Route

• Under the Direct Route the ESOP is approved of and administered by and/or with the approval of the Company’s Board of Directors. As per the provisions of the Companies Act 2013 an ESOP scheme should be drafted and approved by the shareholders’ by passing a special resolution.

• Once the ESOP scheme has been approved by the shareholders, it should be implemented and governed in the manner set forth in the ESOP document so approved. The Board of Directors should issue to their employees a Letter of Grant stating the number of Options being granted to them along with other details such as the Vesting Period and the Exercise Price at which the Employee will be entitled to exercise the Options.

• The Direct Route is simpler and is a generally recommended route of ESOP implementation for start-ups.

The Trust Route

• The formation of a trust for the purposes of implementing an ESOP is more complex than implementing an ESOP via the direct route.

• For the implementation of an ESOP under the trust route, a trust is formed as per the provisions of the Indian Trust Act 1882. A Trust Deed is executed and has to be registered with the jurisdictional sub-registrar.

• Under this route shares and/or options are not allotted directly to the employees. The shares are first received by the Trust by any of the following methods:

1. Shares may be allotted to the Trust;

2. The Trust may purchase the shares from existing shareholders in the open market;

3. The owner of the Company may sell shares of his holding to the Trust

• The Trust arranges for funds to purchase these shares either through a loan from a financial institution or from a seller of shares or even from the issuing company (as permitted under the provisions of section 77(2)(b) and (c) of the Companies Act.

• If the Employees decide to exercise their Options the Trust allots the shares to the Employees and the Exercise Price received by the Trust is used by it to repay its loans.

• Trust Route is the second method of issuing shares pursuant to an ESOP scheme. In this method, a Trust is specifically created and registered for the purpose of implementing ESOP Plan. A company drafts a scheme and gets it approved from the members of the company. Simultaneously, a Trust is formed and registered to act as an intermediary between the company and employees. As and when options are exercised by the option holders, Trust is responsible for issuing shares to employees. In this structure, trust is formed and funded by the company itself. The capital of the trust and further funding requirements are fulfilled by the company by way of loan. The funds are then utilized by the trust to acquire shares either by subscribing to the issue of shares by the co. or from the secondary market. Generally, it is observed that shares are transferred by the promoters of the company. Further, as and when options are exercised by the employees, shares are transferred to them in conformity of the ESOP Scheme.

Procedure for Issue of Shares via ESOP

Step 1: Check the Articles for any specific provision on issue of share under ESOP

1. Check the Articles to understand if any specific provision has been provided with respect to issue of share under ESOP

Step 2: Hold Board Meeting

Action to be taken in the Board Meeting:

1. Authorisation for issue of shares under ESOP
2. Formation of Compensation Committee
3. Calling of General Meeting for approval of shareholder by way of ordinary resolution
4. Issue notice of General Meeting

Step 3: Issue Notice of General Meeting

Notice of General Meeting shall be send at-least 21 clear days and explanatory statement shall disclose the details:

1. Brief description of scheme and total no. of ESOP to be granted.

2. Appraisal process

3. Vesting requirements

4. Exercise price or pricing formula

5. Exercise period

6. Lock in period

7. Scheme implementation through company or trust

Step 4: Hold General Meeting

Hold General Meeting for approval of shareholder by way of Ordinary Resolution:-

1. Authorisation for issue of shares under ESOP

2. Formation of Compensation Committee

3. Approval of shareholders by way of separate resolution is required in case of:

(a) grant of option to employees of subsidiary or holding company

(b) grant of option to identified employees, during any one 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.

Step 5: Hold Compensation Committee Meeting

a) No ESOP shall be offered unless the company constitutes a Compensation Committee for administration and superintendence of the ESOP.

b) The Compensation Committee shall be committee of Board of Directors consisting of majority of Independent Directors.

Step 6: Hold Board Meeting

1. Company shall allot the shares under ESOP.

2. Issuance of share certificates

3. Authorisation for stamping of shares

Step 7: Filing of Form PAS-3

1. After allotment of shares, intimation of such allotment shall be filed with Registrar of Companies within 30 days of such allotment

Step 8: Maintenance of Register

1. Company shall maintain a register of ESOP in SH-6 at registered office of the company or such other place as Board may decide.

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