Demystifying ESOP vis a vis Indian Private Limited Companies – Part II

The Routes available for the creation of an ESOP

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

1. Direct Route; and

2. 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:

a. Shares may be allotted to the Trust;

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

c. 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.

Glossary related to Employee Stock Option Plans (ESOPs)

1. 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-

(i) A permanent employee of the company who has been working in India or outside India; or

(ii) A director of the company, whether a whole time director or not but excluding an independent director; or

(iii) 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-

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

(ii) 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.

2. Employee Stock Option shall have the following meaning as given under section 2(37)) of the Act: ‘‘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.’

3. Eligibility Criteria shall refer to the criteria or requirements that Employees will be required to meet in order to be able to participate in the Plan. The eligibility criteria will be set in compliance with the Applicable Law.

4. Exercise of an Option means the expression communicated to the Company by an Option Grantee of his/her intention and/or decision to purchase and/or subscribe to the Shares underlying the Options vested in him/her in pursuance of an ESOP in accordance with the procedure laid down therein.

5. Exercise Date shall mean the date on which the Company/Corporation shall have received written notice/Exercise Letter communicating the Option Grantee’s intention to Exercise his/her Option.

6. Exercise Letter shall mean the letter that the Option Grantee must give to the Company/Corporation expressing his intention and/or decision to Exercise his Options.

7. Exercise Period means such time period after Vesting within which the Employee should Exercise the Options vested in him in pursuance of the ESOP.

8. Exercise Price shall mean the pre-determined price which the Option Grantee will have to pay to the Company as a consideration for the Options being Exercised by him in pursuance of the ESOP.

9. Grant means the process by which the Company/Corporation issues Options to the Employees under the ESOP.

10. Grant Date shall mean the date on which the Board and /or Committee of the issuing Company determines and approves of the Grant of Options to Employees who meet the Eligibility Criteria.

11. Option Agreement shall refer to the agreement between the Option Grantee and the Company setting forth the terms and conditions of the Grant of Options to the Option Grantee.

12. Option Grantee shall refer to an Employee who has been granted an Employee Stock Option in pursuance of the ESOP.

13. Plan shall refer to the Employee Stock Option Plan.

14. Promoter shall be construed to have the same meaning as assigned to it under Section 2(69) of the Companies Act 2013 and shall therefore mean:

A person:

(a) Who has been named as such in a prospectus or is identified by the Company in the annual return referred to in section 92;

(b) Who has control over the affairs of the Company, whether directly or indirectly, whether as a director, shareholder or otherwise;

(c) In accordance with whose advise, directions or instructions the Board of Directors of the Company is accustomed to act:

Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity;

15. Promoter Group shall be construed to have the same meaning as assigned to it under the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 and shall therefore include:

(a) The Promoter;

(b) An immediate relative of the Promoter (i.e. any spouse of that Promoter or any parent, brother, sister or child of the person or of the spouse); and

(c) In case promoter is a body corporate:

– A Subsidiary or Holding Company of such body corporate;

– Any body corporate in which the promoter holds ten percent or more of the equity share capital or which hold ten percent or more equity share capital of the Promoter;

– Any body corporate in which a group of individuals or companies or combination thereof which hold twenty percent or more of the equity share capital of the issuer; and

(d) In case the Promoter is an individual:

– Any body corporate in which ten percent or more of the equity share capital is held by the Promoter or immediate relative of the Promoter or a firm or Hindu undivided family in which the Promoter or any one or more of his immediate relative is a member;

– Any body corporate in which a body corporate as provided in (a) above holds ten percent or more of the equity share capital;

– Any Hindu undivided family or firm in which the aggregate shareholding of the Promoter and his immediate relative is equal to or more than ten percent of the total; and

(e) All persons whose shareholding is aggregated for the purpose of disclosing in the prospectus under the heading ‘shareholder of the Promoter Group’.

16. Relevant Date means:

(a) In the case of Grant the date on which the Board and /or Committee determines and approves of the Grant of Options to Employees who meet the Eligibility Criteria;

(b) In the case of Exercise, the date on which the Company/Corporation shall have received written notice/Exercise Letter communicating the Option Grantee’s intention to Exercise his/her Option.

17. Shares shall refer to Equity Shares of the Company arising out of the Exercise of Options granted under the ESOP.

18. Unvested Options shall refer to an Option in respect of which the relevant Vesting Conditions set forth in an ESOP have not been fulfilled and as such, the Option Grantee has not become eligible to exercise the Options.

19. Vesting shall mean the fulfillment of the conditions as set forth in an ESOP as a result of which the Option Grantee has earned the right to exercise and/or subscribe to the Shares underlying the Option granted to him/her.

20. Vesting Conditions means the conditions subject to which the Options are granted to the Option Grantees in pursuance of an ESOP.

21. Vesting Period is the period within which the vesting of the Options granted to the Options Grantees in pursuance of an ESOP takes place.

22. Vesting Schedule shall refer to the schedule included in the Option Agreement setting forth the number of shares that will vest in the Option Grantee over stipulated periods of time;

23. Vested Option means an Option in respect of which the relevant Vesting Conditions set forth in an ESOP Plan have been fulfilled and as such, the Option Grantee has the right to exercise and/or subscribe to the Shares underlying the Option granted to him/her.

The above information represents basic information about an ESOP in respect of a Private Limited Company in India and in no way represents any professional legal advice regarding the same. For an in-depth understanding of the concept of ESOPs professional advise is recommended.

By Geeta Daswani
Geeta.daswani@daswanianddaswani.com

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