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Concept of an Employee Stock Option Plan or ESOP:

·         The ESOP is a successful method for keeping employees engaged and committed to a company by offering those stock options

·         Businesses recruit and manage top talent using Employee Stock Option Plans (ESOPs). Employees are encouraged to purchase shares of ownership at a predetermined rate. These plans are used to encourage long-term loyalty from the workforce and to motivate employees to deliver better work and show dedication to the organization.

·         ESOPs are a popular employee benefit program that benefits both the company and its staff.

·         ESOP is an employee benefit plan where the worker receives shares and 100 shares vest each year once a year has passed. The value of the shares to employees is linked to the company's value, which helps control staff turnover.

·         ESOP has pros and cons that must be considered, and it is essential to understand various plans such as the stock option plan.

Advantages of Implementing an Employee Stock Option Plan

-          ESOPs are tax-advantaged and provide fair value to shareholders

-          It allow for a "low and slow" ownership shift

-          Benefit people who work for the company for a long time

-          Produces independent, long-lasting businesses that are tax-favoured

-          Establishes and maintains a legacy for the company.

Comprehensive guide for Employee Share Option Plan 2023-2024

- Check articles for ESOP provisions

- Include compensation committee members and meeting date

- Notice of general meeting with ESOP details

- Hold general meeting for shareholder approval

- Draft copy of certificates required

- File Form-PAS-3

- Disclosure in Director Report

- Maintain register of ESOP in SH-6, authenticated by CS or authorized person.

Benefits and Limitations of Implementing an Employee Stock Option Plan

Benefits:

-          Some individuals may question the merits and drawbacks of an employee stock option plan. In order to provide further insight, a few key points regarding the advantages and disadvantages of this compensation strategy will be discussed.

-          An employee stock option plan can help many older people who want to sell their businesses find a buyer. There are lots of businesses for sale, and this plan can help.

-          ESOPs can give tax benefits to a company if they follow specific rules. Creating a plan for employees to own stocks in the company can be costly, but it might be cheaper than selling the company. The cost depends on factors like the type of business and how it's organized.

-          The implementation of an Employee Stock Option Plan (ESOP) can serve as a beneficial exit strategy for middle-market businesses. It allows the business to maintain stability and reward key employees for their performance and commitment while still retaining ownership by trusted individuals. This decision to give employees the reins can reflect positively on the owner, and the sale of the company to an ESOP can be made in a gradual or all-at-once manner, giving the owner flexibility in their exit strategy.

Limitations:

-          The administration of ESOP schemes can be both complicated and costly. Initiating a basic ESOP design requires a minimum budget of ₹40,000.

-          In addition to the initial cost, there are annual fees for services such as trustees, legal advisors, administrative and compliance support, as well as valuation services. Further transaction costs can be incurred if new employees are required to be hired, or if there is a retirement of existing employees. Furthermore, the valuation derived from an ESOP may be inferior to the value determined from a competitive selling process with multiple bidders.

-          Depending on the industry, a company may experience a selling valuation which is up to 20-30% higher, compared to the valuation obtained through an ESOP scheme.

-          Due to the fees, payments, and ESOP buyback requirements, the company has less money to invest in expansion, hiring talent, exploring new markets, and other resources. This lack of funds makes it challenging for the business to focus on development and innovation as supporting the current strategy becomes a higher priority than cash flow and liquidity, which are constantly strained.

-          It can be difficult to get a fair assessment of stock ownership plans because many parties involved benefit from third-party fees. To avoid conflicts of interest, many plans have independent trustees representing member interests and external companies handling plan administration and record keeping. It is also recommended for companies to have Fiduciary Liability Insurance to protect against allegations of mishandling employee benefits.

 Functionality of an Employee Stock Option Plan

ESOPs are a way for companies to offer their employees the chance to buy company shares at a discounted price. The shares are held in trust for a specific period of time, known as the vesting term.

Once the vesting time is up, employees can exercise their ESOPs and purchase shares. The number of shares, their price, and the recipients are all determined beforehand. This allows chosen employees to buy company shares at prices below the market value.

ELIGIBILITY CRITERIA FOR THE EMPLOYEE STOCK OPTION PLAN

The Indian Revenue Service (IRS) states that in order to be eligible for an ESOP (Employee Stock Ownership Plan), an employee must be at least 21 years old and eligible for ESOP at the time of joining the company. If the plan has immediate vesting, the employer can restrict eligibility to employees who have completed two years of service.

 Employee Stock Option Plan 2023-2024 Checklist

- Check for provisions on shares under employee stock option scheme

- Include date and members of compensation committee in board meeting

- Notice of general meeting with number of ESOP to be granted

- Hold general meeting for approval of shareholders by ordinary resolution

- Authorize issue of shares under ESOP and formation of compensation committee

- Compensation committee must consist of majority of independent directors

- Shareholder approval by separate resolution

- Requirement of draft copy of certificates

- File Form-PAS-3

- Disclose in Director Report (DR)

- Maintain register of ESOP in SH-6 at registered office or board-approved place

- Authenticate entries in register by CS or authorized person

What is the process of registering an Employee Stock Option Plan?

Create the ESOP Regulations

The ESOP regulations outline the conditions that govern all options provided under the plan, including the procedure for granting options, the rules for employees to exercise their options, and the implications for options in the event of an exit or an employee's departure. The document will contain the following sections:

Section 1: A letter of grant that outlines the terms of the options intended for recipients.

Section 2: The prescribed form of the exercise notice to be submitted to the company when an option holder wishes to exercise their vested options.

Section 3: An option certificate that records the number of options, exercise price, and vesting provisions.

Consent to the regulations and the allocation of shares

To proceed with implementing the ESOP rules and establishing your option pool, it is necessary for your directors and shareholders to review and approve the rules. Once they are satisfied, they will be required to sign the appropriate corporate approval documents.

Are Employees Highly Benefited by ESOPs?

When a company wants to motivate its employees, it may offer them stock options. This serves as an incentive for employees to give their best because they can profit if the company's stock prices increase. While the main advantages of ESOPs for employers are motivation, employee retention, and rewarding effort, there are other noteworthy benefits as well. Some of these benefits include:

Advantages of ESOPs are:

- Financial incentive is given to employees in the form of discounted company stock.

- Employees get a chance to own a part of the company and profit from its growth.

- ESOPs provide tax benefits such as lower capital gains tax rates.

- Selling shares of ESOP, employees can diversify their investment portfolio.

- ESOPs can act as a valuable retirement savings source, especially if the company's stock performs well over time.

BOARD AND SHAREHOLDER AUTHORIZATION

The following resolutions need to be approved:

1. The rules for the Employee Stock Option Plan (ESOP) must be authorized.

2. The total number of options in the ESOP pool needs to be determined.

3. The board should be given the authority to grant options to chosen recipients.

4. Authorization should be granted to issue shares when the options are exercised.

Shareholder Waivers and Consents

If your constitution and shareholder's agreement include pre-emptive rights regarding the issuance of new shares, shareholders with these rights must sign a waiver for any options granted through the ESOP.

·         Granting options to recipients requires proper documentation and communication. To begin the process, ask your corporate secretary to prepare written directors' resolutions approving the grant of options to a specific recipient.

·         Once you have received the resolutions, send each recipient their grant letter. The option certificate can be found in schedule 3, but make sure to leave the schedule blank and provide a separate option certificate to the recipient. Create a new Word document for this purpose.

·         Additionally, it's important to maintain an option register internally. This register should include details such as the options granted, vesting schedules, expiry dates, and exercise dates. Keeping this record will help you stay organized and informed.

ESOPs, or Employee Stock Option Plans, are a popular way for companies to compensate their employees by offering them the chance to buy company stock at a discounted price. Let's take a look at the tax implications of ESOPs:

TAX CONSEQUENCES OF ESOPs AND COMPUTATION OF ESOPs

·         When an employee exercises their ESOPs by purchasing the shares, they are required to pay tax on the difference between the exercise price and the fair market value of the shares at that time. This tax is considered a part of their salary income.

·         If the employee decides to sell the shares they acquired through the ESOPs, they will be subject to capital gains tax. The specific rate of this tax will depend on how long the shares were held before being sold.

·         Additionally, if the company pays dividends on the shares owned by the employee, those dividends will be subject to taxation based on the applicable tax rate.

·         In summary, when employees exercise their ESOPs, they must pay tax on the difference between the exercise price and the fair market value of the shares. If they later sell these shares, they will be subject to capital gains tax. Finally, any dividends received on the shares will also be taxed accordingly.

-          PAY ATTENTION: The difference between the sale price and the FMV on the share activation date is liable to Capital Gains Tax.

-          BE AWARE: After 12 months, gains surpassing ₹1 lakh are subject to a 10% tax.

-          NOTE: If shares are sold within a year, the gains will be subjected to a 15% tax rate.

Step by step process for issuance of Employee Stock Option Plan

To issue shares through an ESOP, the Article of Association (AOA) must authorize it. If the AOA lacks this clause, an extraordinary general meeting must be conducted to amend the AOA and include this provision.

1.       The first step is to prepare an ESOP draft in compliance with the Companies Act of 2013.

2.       Next, a board meeting should be held to present the draft resolution to all directors and shareholders.

3.       All shareholders and directors must approve the ESOP scheme for further resolution.

4.       During a general meeting, the price of the shares to be issued, along with the fixed time and date, should be discussed to pass a special resolution for issuing the ESOP.

5.       To pass the board resolution, an MGT-14 form must be filed with the ROC. The draft minutes should be distributed to all directors within 15 days of the conclusion.

6.       In the general meeting, the special resolution for issuing shares under the ESOP scheme must be passed to the employees, directors, and officers of the company. After passing the special resolution, the MGT-14 form must be filed with the RoC within 30 days.

7.       A register of employee stock options must be created and maintained in form SH-6, recording all the details

Who is Eligible to Receive the ESOP?

In India, the allocation of ESOPs is regulated by various laws, including the Companies Act, 2013, and the Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014.

- ESOPs issued to permanent employees, including those working in India or abroad

- ESOPs can also be issued to directors, but not independent directors

- ESOPs can be issued to employees of subsidiaries or holding companies, but eligibility criteria must be met

- ESOPs can be issued to employees who are members of the promoter group, but not promoters themselves

- ESOPs cannot be issued to non-employees (consultants, advisors, contractors), but equity shares can be issued to non-employees under certain conditions.

ESOP: The Procedure and Allocation

In India, the process of granting and allocating ESOPs involves several steps.

1.       Firstly, the ESOPs specify the number of shares, exercise price, and vesting period for eligible employees according to the scheme's terms.

2.       Once the vesting period is over, employees can exercise their ESOPs at the agreed exercise price. The company must ensure it has enough liquid shares available for the ESOP scheme.

3.       After exercising their options, employees are allotted shares, which must be paid within 15 days of exercising the ESOPs.

4.       The company must then transfer the shares to employees' Demat accounts within two days of allotment and inform the stock exchange.

5.       Employees are required to pay the exercise price for the allotted shares within six months. Throughout this process, the company must comply with all applicable regulations and reporting requirements set by SEBI.