By using the Employee Stock option, employers can motivate and maintain value within their teams. They could be able to retire from it if they sell them after a set period of time. Through the Employee Stock Option Plan, a business with a proven track record can attract more investors by allowing more people to buy shares of the company at a predetermined price.
ESOP for Private Companies in India
Importance of ESOP
ESOPs benefit firms by providing their workers with various rights, including the right to buy stocks in the company at a fixed price at the end of a specified period. Secondly, it aids the employer in retaining the company and ensuring a high level of productivity in the workplace. The adoption of ESOP in India is driven by the need for better management and alignment of interests that can be achieved by empowering employees with an ownership stake.
The Benefit of ESOP to Employees
ESOPs give employees an option or right to buy the shares of the company at a pre-determined price. It is not an obligation, so if the share price falls, the employee can choose not to buy the shares. ESOPs are beneficial to employees as it encourages them to work harder and be more invested in the company’s success
Benefits of ESOPs for Employers
Earning Dividends
A fraction of the company’s profits is disbursed to its shareholders in the form of dividends. Consequently, employees can secure extra dividend income, directly benefiting from their contributions to the company’s profitability.
Acquiring Shares at a Reduced Price
When employees exercise their ESOPs, they typically acquire allotted shares at a minimal cost, allowing them to invest in the company at a preferential rate.
Enhanced Employee Retention
The vesting period requirement before employees can exercise their ESOPs makes it easier to retain them.
Increased Productivity
Since employees have a personal stake in the company’s profits, ESOPs can elevate employee productivity, ultimately contributing to the company’s profitability
A Tool for Talent Attraction
ESOPs serve as supplemental compensation plans that aid employers in attracting and retaining talented employees. Particularly for startups, ESOPs are instrumental in attracting top talent during the initial stages when offering high salaries may not be feasible
Procedure for Issue Employee Stock Option Plan
The Employee Stock Ownership Plan is governed by Section 62(1)(b) of the Company Law of 2013 and the SEBI Guidelines from 1999. A generalized procedure for issuing ESOP by a private company is as follows:
- The company should ensure that the Articles of Association (AoA) authorizes for issuance of shares through ESOP.
- If the AoA does not authorize, the company should hold an extraordinary general meeting to alter the AoA to include the provisions of issuance of shares through ESOP.
- The board meeting should be held for the passing of the resolution and getting the shareholder’s approval for the ESOP Scheme.
- The company should draft an ESOP Scheme and file it with the Registrar of Companies (RoC) within 30 days of passing the resolution.
- The company should also file Form MGT-14 with the RoC within 30 days of passing the resolution.
Functioning of an ESOP Plan
Under ESOP in India, employees are granted a number of shares and an option to purchase them at a particular price over a certain period of time. ESOPs are granted to select employees wherein an employee is allotted a particular number of shares in the company at a certain price that can be purchased after a predefined period of time.
In case of a startup company, recognized by DPIIT, it is exempted from the restrictions of ESOP for its for its promoters and directors, holding more than 10% of outstanding equity shares for 10 years from the date of its incorporation.
Why Do Companies Offer ESOPs to Their Employees?
The main reason behind this offer is to retain and attract talent in the company. These ESOPs are distributed in a step-by-step manner. For instance they are shared mostly at the end of the fiscal year. It helps them to stay with the company to receive the grant. Offering ESOPs extends beyond employee retention, it also aims to transform their workforce into stakeholders in the organisation.
This is especially valuable in addressing high attrition rates, common in many IT companies, as ESOPs can help mitigate this issue. Furthermore, startups, often constrained by limited financial resources, leverage ESOPs as a means to attract talent by offering equity in their company, thereby making their compensation packages more competitive in lieu of higher salaries.
FAQs
How does ESOP work in private companies?
ESOPs in private companies work by granting employees an option or right to buy shares of the company at a pre-determined price. The company sets up a trust to hold the shares, and the employees are granted a certain number of shares and an option to purchase them at a particular price over a certain period of time. The employees can exercise their option to buy the shares after the vesting period, which is the period after which the employee can exercise the option to buy the shares. The shares are then transferred to the employee's demat account.
Who is eligible for ESOP employee?
ESOPs can be granted to the employees of the company only. In case of a startup company recognized by DPIIT, the promoters and directors holding more than 10% of outstanding equity shares for a period of 10 years from the date of its incorporation are exempted from the restrictions of ESOP.
Is ESOP given to all employees?
ESOPs are not given to all employees. Companies usually grant ESOPs to select employees. The selection of employees for ESOPs is based on various factors, including the employee's performance, seniority, and potential for growth.
Is ESOP only for listed companies?
ESOPs are not only for listed companies. Private companies can also issue ESOPs to their employees.
Is ESOP deducted from Salary?
ESOPs are not deducted from salary. ESOPs are granted to employees as an additional benefit.
Is ESOP part of CTC?
ESOPs are not part of Cost to Company (CTC). ESOPs are granted to employees as an additional benefit and are not included in the employee's salary package.
What is the lock in period for ESOP?
The lock-in period for ESOP is the period after which the employee can exercise the option to buy the shares. According to SEBI guidelines, there must be a one-year lock-in period between the grant of options (i.e. issuance of the ESOP) and the option's vesting. The employer can establish their own lock-in period for exercising the option.
Which employee is not eligible for ESOP?
Professionals working for or in the company who are not on the payroll of the company are not eligible for ESOP. Only employees of the company are eligible for ESOPs.
Who Cannot participate in ESOP?
Directors holding more than 10% of outstanding equity shares are subject to restrictions on the issue of ESOPs.
How do ESOPs differ from traditional stock options?
ESOPs serve as retirement plans with tax advantages, while stock options may face income taxation upon exercise. ESOPs typically involve gradual vesting, granting ownership over time, whereas stock options can have immediate or gradual vesting. ESOPs offer substantial company ownership to employees, whereas stock options often provide a modest ownership share.
What are the eligibility criteria for employees to participate in an ESOP program?
Most ESOPs require employees to be at least 21 years old and have worked for the company for at least one year to be eligible to participate. However, some ESOPs may have different eligibility requirements, such as a longer vesting period or a higher minimum age requirement.
Can ESOPs help attract and retain top talent in a company?
Yes, ESOPs can be a valuable tool for attracting and retaining top talent. Employees who own shares in the company are more likely to be engaged and motivated, as they have a direct stake in the company's success. Additionally, ESOPs can offer employees a competitive retirement benefit.
Are there any tax implications for employees who receive ESOPs?
Employees who receive ESOP shares may have to pay taxes on those shares, depending on how they are distributed and how the employee chooses to vest them. However, there are also some tax benefits associated with ESOPs. For example, employees can defer paying taxes on ESOP shares that are vested in a tax-advantaged retirement account.
What is the vesting period for ESOPs, and how does it work?
The vesting period for ESOPs is the amount of time that employees must work for the company before they fully own their ESOP shares. Vesting periods can vary from plan to plan, but they are typically between three and seven years. During the vesting period, employees gradually gain ownership of their ESOP shares as they continue to work for the company. If an employee leaves the company before they are fully vested, they may forfeit some or all of their ESOP shares, depending on the plan's rules.
Can employees sell their ESOP shares on the open market?
In most cases, employees cannot sell their ESOP shares on the open market. Instead, employees must sell their shares back to the company or to the ESOP trust. The company or ESOP trust is typically required to purchase the shares at fair market value.
How can a company's stock performance impact the value of ESOPs for employees?
The value of ESOPs is directly tied to the value of the company's stock. If the company's stock price goes up, the value of the ESOPs will also go up. Conversely, if the company's stock price goes down, the value of the ESOPs will also go down.
What role do ESOPs play in aligning employee interests with those of the company?
ESOPs can help to align employee interests with those of the company by giving employees ownership in the company. When employees own shares in the company, they are more likely to be engaged and motivated, as they have a direct stake in the company's success. Additionally, ESOPs can help to create a more cooperative and collaborative work environment.
Are there any industry-specific regulations or guidelines related to ESOPs?
Yes, there are some industry-specific regulations and guidelines related to ESOPs. For example, ESOPs in the financial services industry are subject to additional regulations by the Securities and Exchange Commission (SEC).
What are some success stories of companies that have effectively implemented ESOP programs?
There are many companies that have successfully implemented ESOP programs. A few notable examples include Publix Super Markets, W.L. Gore & Associates, and Patagonia. These companies have all credited their ESOPs with helping them to achieve success.
Conclusion
ESOP is useful to both the business and its employees. It is ideal for startups when workers may receive rewards after the business goes public. If they meet the requirements, any employee of the company may be given an Employee Stock Ownership Plan offer. Check Vakilsearch to know more about ESOP and its services.
Read More:
- Procedure for Issuing ESOP
- How to Design an Effective Employee Stock Option Scheme?
- Starting ESOP Scheme Within a Company
