Employee stock option scheme (ESOP)

1. JUNE 2014
ESOP(s) for Young Entrepreneurs
MANU GROVER (FCS, LLB, LIII, IIM-C)

2. ✪ ESOPs – General Parlance
✪ Importance of ESOP(s)
✪ Entitlement for ESOP(s)
✪ Pricing for ESOP(s)
✪ Key terminology
✪ Life Cycle of ESOP – Employee and Company Perspective
✪ Taxation on ESOP
✪ Statutory applicable legistation
✪ FAQ
Index

3. ESOPs is an agreement between a Company and its employees that gives
employees right to acquire a predefined number of equity shares of the
Company at the pre-agreed value within a stipulated time frame. Thus,
ESOP scheme is important which contains the exhaustive details.
ORIGIN:
The concept was first introduced in USA in 1950’s and Infosys pioneered
the same in India in 1994. The whole idea was to bring the sense of
ownership which acts as a strong motivational force towards the growth of
the Company.
ESOP(s) – General Parlance

4. ESOPs – It’s a investment in the vision and growth story of the Company.
The ESOP(s) in young enterprise becomes valuable due to its pace and
scalability potential.
Unlike cash salaries which has a present cash value, ESOP has a high
potential value which can have an extra motivational factors for future
growth potential.
“HIGH RISK (CASH SALARY FORGO) = HIGH VALUE (GOOD VALUATION)”
Importance of ESOP(s)

5. Entitlement for ESOP(s)
ESOPs – is a right but not an obligation for following persons;
a) Permanent employee (whether working in India / or abroad);
b) Director of the Company (excludes independent Director)
c) The above persons of a subsidiary/holding or associate company
Excludes, an employee who is a promoter or Director who either himself
or through relative holds more than 10% of the outstanding equity
shares of the Company.

6. ESOPs – are ‘freely’ priced. Though there are vaious accounting principles
guiding the norms vis-a-vis INTRINSIC VALUE METHOD OR FAIR VALUE
METHOD
Illustration:
Company ‘A’ sold equity shares in the last round at INR 5000 per share to
an investor. An employee who works at a salary of INR 7 Lacs per annum.
Thus, we will propose allotting you 140 ESOP shares, valued at INR 7 Lacs
per annum (towards 50% variable pay) i.e. 140 shares x INR 5000 per
share.
Pricing of ESOP(s)

7. ✪ Exercise - It is the act of an application being made by the Employee to the Company to have
the Options vested in him issued as Shares upon payment of the Exercise Price. Exercise can
take place as specified after Vesting.
✪ Exercise Period - The period from the date of vesting of options till the date the options can be
exercised. On the expiry of the Exercise Period, any Options that have not been exercised will
lapse and cease to be valid for any purpose.
✪ Exercise Price - The amount to be paid by an Optionee at the time of Exercise of his option.
This price is determined at the time of grant and remains constant over the term of the option.
✪ Grant - Grant means issue of options to employees under ESOP
✪ Option - Option means a stock option granted pursuant to the Plan.
✪ Vesting - Vesting means the process by which the employee gains full rights to the options
granted to him in pursuance of ESOP.
Key Terminology

8. #LegalBuddy – a management consultancy company has 1000 equity shares priced at INR 10 each.
The firm offers X, an employee of the Company a ESOP under which on April 01, 2014 (GRANT
DATE), option of 150 equity shares at INR 10 (OPTION PRICE), after three years (VESTING
PERIOD)
Thus after three years (March 31, 2017) say value of each share is INR 50 and Mr. X, is still working
with the Company, then he may exercise the option by paying INR 1500.00 (150 shares @ INR 10),
(EXERCISE PRICE).
As per the approved ESOP Scheme the shares, may have a further lock-in-period of 01 years after
which the same may be sold by Mr. X. Thus, the gain for remaining with the Company to Mr. X is INR
6000 (Value of shares for 2017, INR 50, less cost of acquistion at price of 2014, INR 10)
Process flow

9. 1 – GRANT
EMPLOYEE RECEIVES
THE RIGHT
2 – VEST
EMPLOYEE EARNS
THE GRANT
3 – EXERCISE
EXERCISE OF RIGHT
BY THE EMPLOYEE
4 – SALE
EMPLOYEE SELLS
THE SHARES
Life Cycle of ESOP
Compensation
Committee
is formed
Drafted ESOP
Scheme is
approved by BOD
ESOP Scheme is
approved by
Shareholders
Stocks are
GRANTED to
Eligible
Employees
Cooling period –
“Vesting period”
(ONE TIME / GRADED)
Employee
exercise the
Option
Exercised shares
are allotted
Employee does
not exercise the
Option
Option expires
Employee / Company’s perspective

10. Taxation on ESOP
Grant of Option
• At the time of
Grant, taxable
event does not
arise
• No tax liability
Vesting of Options
• At the time
when the
options are
vested, Taxable
Event does not
arise
• No tax liability
Exercise of
options/Allotment
of shares
• Taxable Event
(Taxable as
Salary Income as
Perquisite)
• Tax liability
Sale of shares
• Taxable Event
(Taxable as
Capital Gain)
• Tax liability

11. ✪ The Companies Act, 2013 read with Rules made thereunder vis-à-vis
Companies (Share Capital and Debentures) Rules, 2014
✪ SEBI (Employee Stock Option Scheme and Employee Stock Purchase
Scheme) Guidelines 1999, as may be amended from time to time
✪ Unlisted Companies (Issue of Sweat Equity shares) Rules, 2003
✪ Income Tax Act, 1961
Statutory Legislation

12. Can a Private Limited Company have an ESOP for particular employee?
- Yes, ESOP can be for particular set of employees or all.
Can Optionee exercise the right before the vesting period?
- No, the grant can be exercised after the expiry of predefined vesting period. There needs
to be a gap of minimum one year between grant of option and commencement of
exercise period (Vesting Period).
Is option expires if Optionee leaves before end of vesting period?
- Yes, the option lapses if the employee leaves before the vesting period, though in case of
death the legal nominees are entitled to exercise the option.
FAQ(s)

13. Is there a lock-in period after the exercise of grant by the optionee ?
- The legislation does not provide for the same, though the management may restricts/put the
lock-in under the ESOP Scheme.
Can Optionee exercise the right after lapse of exercise period ?
- No, one the exercise period lapses the optionee cannot claim the grant.
Is the option taxable under the hand of Optionee ?
- Yes, the Optionee has to bear the tax.
- Perquisite at the time of exercise: FMV-Exercise Price
- Capital gain tax: Net sale-FMV (STCG-10%, LTCG-Nil)
FAQ(s)