Procedure For Issue Of ESOP

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Every business entity is only as strong as its weakest link, which makes the business ensure that its employees are on board and happy. Employees are happy when they have a sense of belonging and are able to identify with the company. Incentives, bonuses and the like are what keeps the employees on their toes.

ESOP (Employee Stock Ownership Plan) is one such scheme wherein the employees obtain a right to invest in the shares of the company at a discounted price at any given future date. Schemes like ESOPs encourage employees to work harder and better. To attract the best talent at the early stages, startups offer ESOP packages to all prospective hires.

Employee Stock Ownership Plan (ESOP)

It is an employee benefit plan that provides the employee with the right to purchase the shares of a company at a discounted price in the near future. The idea behind this is to better the performance of the company and aim at an increase in the value of the shares by involving the employees as stockholders, incentivising them to contribute to the company’s success, being personally vested in the company.

ESOPs normally have a vesting period, which refers to the time period for which the employee must work in order to exercise his right to purchase the shares under the ESOP.

Procedure for the Issue of ESOPs

  • Drafting of an ESOP Scheme and Approval in the Board Meeting

The ESOP Scheme is a document containing various clauses including:-

  • Administration of the ESOP.
  • Details regarding the exercise period and vesting period.
  • The size of the equity pool.
  • Employee cessation.

The addition and modification of clauses can be tailored to suit the company’s requirements. Care should be taken to ensure that the ESOP Scheme is drafted to benefit the employees, bearing in mind that the objective is to attract and retain top talent. If this is not followed, it defeats the whole purpose.

Once the draft is ready, the same is to be approved by the Board of Directors in the Board Meeting.

  • Approval in the EGM

A notice has to be sent to all the members regarding the Extraordinary General Meeting (EGM) within the stipulated time period, along with an agenda of the meeting. The ESOP scheme has to be approved by the shareholders at this EGM via the passing of a special resolution. Therefore, the votes for must be at least three times the votes against.

  • Filing with the Registrar of Companies (RoC)

The board resolution and the special resolution passed in the EGM will have to mandatorily be filed with the RoC in Form MGT- 14 within the prescribed time period.

  • Granting of Options and Maintenance of Registers

Once the ESOP Scheme is approved, stock options will be granted to the eligible employees. The time period for vesting should be at least one year from the grant date. At the time of exercising the employees’ options, Form PAS – 3 is to be filed with the RoC. In addition to this, a Register of ESOP is to be maintained via Form SH – 6.

Benefits of ESOP to Startups

  • Attracting prospective talent and retention of existing talent

It is imperative for startups to ensure that their best talent stays with the company from the very beginning. This, in turn, ensures stability in the growth levels of the business.

By offering ESOPs, the startups give the employees a sense of pride and belonging in the fact that they are part owners in the company. This pushes the employees to work towards the success of the company, considering that they have a personal interest in the well being of the company.

The vesting period principle is another feature that ensures there is no high labour turnover since the options vest only after the specific vesting period pertaining to the plan.

  • Greater control over the cash variables of the company

In the initial years of business, it is next to impossible for a startup to offer large salaries laden with monetary perquisites. In order to attract the best talent in the field, the offer has got to be attractive and appealing. Here’s where ESOPs serve as a boon to startups. 

ESOPs provide the company with a bit of breathing space so as to stabilise cash flows throughout the vesting period since there is no outflow at the time of granting the ESOP.

  • Enable active participation in the growth of the company

In order to see a substantial increase in the value of the company’s shares, there must be substantial growth to support it. And substantial growth is achieved on the back if every employee is fully committed towards the success of the company. ESOPs instil in the employees the fire and the drive to push the company to those limits since they are personally vested in the company and its well-being.

  • Raise additional equity capital, refinance unpaid debt and more

ESOPs may be leveraged with third-party lenders in order to raise additional equity capital, refinance unpaid debts and more. It enables the startup to attain more funding if and when funding is necessary.

ESOPs, especially in startups, can be executed effectively only when the plan is well-drafted right from the initial stages.

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