Start-up culture is at its’
boom in India. Start-up attracts Venture Capital (VC) or Private Equity (PE).
VC/PE investment sometimes requires hiring specialists. For Start-ups, it’s not
easy to offer competitive pay to attract talent. Employee Share Option Scheme
(ESOP) as part of salary package offered, comes in handy. At other times, ESOP
is offered to retain talent and give a sense of ownership.
Flipkart deal has showered
fortune on its employees holding shares under ESOP. Paytm and Citrus are other
examples. But it’s the positive part of the story. Some startups shut down
after receiving investment. Their ESOPs never get listed on any exchange or are
bought back by any investor. ESOPs are not always about startups. Most of the
big corporate like HDFC, ITC, Wipro, L&T etc. have awarded shares to
recognize and reward employees.
Like many other things,
ESOP story is two sided as well. This article talks about ESOP from employee
side. In the following article, we will discuss ESOP from the view of employer
i.e. company.
What is an ESOP: ESOP is usually known
as Employee Stock Option Plan in legal terms it may be called
by different names as:
· Employee Stock Option
Scheme
· Employee Stock Purchase
Scheme
· Stock Appreciation Rights
Scheme
· General Employee Benefits
Scheme
· Retirement Benefit Scheme
By whatever name called,
all the above schemes offers shares/securities of the Company for direct or
indirect benefits of its employees. Here the important thing to be noted by an
employee is that the ESOP needs not to be necessarily offered by the Company at
whose payroll you are working. You may also receive ESOP from your holding
company or from any other company of the same group.
In layman’s language an
ESOP is an offer given to employee by his employer to buy shares of the Company
at a predefined price and in a phased manner.
ESOP as part of offered
package (Remuneration negotiation): Always analyze risk
associated with accepting an offer having ESOP. Startups are unlisted
entity. So, ESOPs by startups will not have liquidity as is available in case
of listed entities. Pay package is often
structured such that shares under ESOP are granted at the end of first year
(like retention bonus) and then you must wait for vesting period of shares to
benefit from share grant. This means you are investing for long term.
Last but not the least,
under ESOP, shares are not given to you for free. You must pay the predefined
purchase price. If all does not go well with the organization, the predefined
price may be a higher price than the face value and market value of those
shares, resulting in loss of speculated gain. Though, we all know that higher
the risk the higher the gain. ESOPs can be offered only
to permanent employees.
My advice is to take
calculated risk. Research ESOP grant timing, purchase price, eligibility and
vesting period before accepting ESOPs as part of pay package.
Eligible employees: ESOP can be offered to
below:
i. A permanent employee of the
company who has been working in India or outside India
ii. A director of the company,
whether a whole time director or not, but not to an independent director
iii. An employee of holding
company
Options under ESOP can’t be
granted to promoters or person belonging to promoter group.
Most enquired questions
about ESOP is - Can the new employee receive options under ESOP? Well.
Compensation Committee of a company has the power to decide who will receive
options under ESOP. A company is free to decide criteria for granting ESOP.
ESOP scheme may be structured in a manner that option can be granted to senior
employees to reward their loyalty, to young talent to retain them and to new
employees to attract talent.
Procedure of ESOP: The implementation on ESOP
consists of three steps:
1. Grant of option
2. Vesting of option
3. Exercise of option
Let’s take an example. Mr. A received 100 no. of options from his
Company which will vest @25% each year from the end of first year of grant.
Here no. of grant is 100. Vesting each year at completion of one year of
receiving of grant will be 25. Mr. A can exercise his right to buy
shares/options so vested at the end of each year. Please note Mr. A can’t buy
the shares/options before their vesting.
Some employee wonder if they can claim the difference in the share price
(i.e. ESOP price – Market price) on exercise date. It can be done only if ESOP
is managed by a trust, securities of the company are listed on stock exchange
and ESOP scheme has such provision.
At the time of receiving
ESOP always check whether your Company is listed or unlisted and options so received
give you right to invest in shares of your company or your subsidiary/holding/
group company. Please remember that shares of unlisted public company or
private company can’t be sold in stock market. In that case, the only liquidity
left is when an investor of the company is ready to buy those shares or the
company itself decides to buy-back its own shares.
Pricing of ESOP and
Lock-in: As an employee you are not going to receive any free share under ESOP.
Exercise price is the price at which you can buy the options vested in your
name. Current regulation gives freedom to the company to determine the exercise
price provided accounting regulation is taken care off. Thus, the company can
give you shares at discounted price.
ESOP scheme may specify a
lock-in period. Lock-in means after buying the shares under ESOP you cannot
sale it till the lock-in period is over. This is usually one year from the date
of exercise of option.
Taxation: Shares purchased under ESOP
are taxed twice:
At the exercise of
option: At the time of exercise of option the price difference between the Fair
Market Price of said shares and the exercise price is treated as perquisites in
the hands of employee and shall be taxed under the head income from salary.
That tax will be deducted at source by the employer and will reflect in Form 16
of the employee.
At sale of shares: ESOP shares will be liable
for short-term capital gain or long term capital gain as the case may be, at
the time of sale. For calculation of tax the price difference between fair
market price at the date of sale of shares and the fair market price at the
date of purchase of these shares will be considered. As at the time of purchase
the difference between exercise price and fair market price would have already
been taxed as perquisites.
When you lose your right
under ESOP: If you retire, resign or
die, ESOP is governed by specific terms of scheme. Below is a general
discussion of these circumstances
i. Termination: The options
not vested on that date expire. Options already exercised by the employee,
remain with the employee. A period is provided for exercise of options already
vested.
ii. Resignation: The options
not vested on that date expire. Options already exercised by the employee,
remain with the employee. A period is provided for exercise of options already
vested.
iii. Death or permanent
disability: All the granted options will immediately become vested in the name
of legal heir of the employee to whom the options were granted.
As an employee you shall also check the clause for treatment of
bonus/right shares, if any, offered during the period of grant till the time of
exercise of option. Effect of change in capital structure or corporate
restructuring like mergers/amalgamations shall also be checked.
ESOP vs bonus: Indians prefer higher
package or bonus than ESOP. ESOP only gives an option to invest in shares of
the company at a pre-determined price. If ESOP is granted as a reward for your
loyalty or to retain your without compromising the bonus or incentive
structure, it is an added advantage
By Nikita Singh
Nikita Singh & Co.
Company Secretaries
nikitasinghandco@gmail.com
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