ESOPs: Worthy Device for Startups

Thinking to Hire Talented Employees?

Hire & Retain best of the human resources

without paying huge chunks of salary;

Why Startups Require ESOP ?

Real value of a startup is not cash but ESOPs

Builds employee-company relationship for

mutual long-term benefit;

A type of non-cash investment of an

Employer to gain human assets.

Keep the employees motivated and

focused in company’s growth.

In small company, an employee puts in the

same amount of effort and grows faster. As

the company grows, its stock value grows.

Startup (less employees), the success return

gets distributed among less number of

people, i.e. an employee earns more in less

time.

Return on ESOPs are considerably higher than

a person’s annual salary.

Know More About ESOPs

Stock Option Plans / Equity Incentive

Plans (commonly referred to as ESOPs)

are one of the most important tools to

attract, encourage and retain

Employees.

What are Stock Options?

Company grants an option to its

Employee to acquire Shares at a future

Date and at predetermined price.

Extending benefits through Stocks is like

creating a win-win situation for both

Employer & Employee.

Types of Stock Options

Stock Options

(Sharing in the Capital of

the Company)

Employee Stock Purchase

Scheme (ESPS)

Employee Stock Option

Plan

(ESOP)

Restricted Stock Units /

Awards

(RSUs / RSAs)

Stocks Indexed Plans

(No sharing in the Capital

of the Company)

Stock Appreciation Rights

(SARs)

Phantom Stocks

Sweat Equity Shares

Employee Stock Option Plan

Employee Stock Option Schemes are the most commonly used forms of Stock

Option Plans.

The option granted under the plan confers a right, but not an obligation on the

employee to take shares of the Company at a predetermined price over a fixed

period.

Example

Grant of

options

Vesting

of

options

Exercise

of Vested

options

Allotment

of Shares

Employee Stock Purchase Scheme

Employee Stock Purchase Plans allow Employee to purchase

Company’s shares, often at a discount from Fair Market Value. The

terms of the Plan determines the tenure and price for possession of

the Company’s shares by the Employees.

Usually, ESPPs are being framed for offering shares as a part of

public issues.

Example

Offer of shares

at discounted

price

Allotment of

shares

If accepted by the Employee

Restricted Stock Units

Under this kind of incentive plan, the Employee is awarded with the

shares subject to fulfillment of certain underlying conditions. If the

said underlying conditions are not fulfilled, then the awarded shares

stand withdrawn.

Example

Grant of

options

Vesting of

options

Exercise of

Vested

options

Allotmen

t of

shares

Underlying Conditions like:

Target / Revenue

Achievement, Performance

based etc..

If Condition fulfilled

Sweat Equity Shares

Sweat Equity Shares mean such equity shares as are issued by company to

its directors or employees at a discount or for consideration, other than

cash, for providing their Know-how or making available rights in the nature of

intellectual property rights or value addition, by whatever name called.

Example

Value a

person’s

sweat

Shareholder’s

ApprovalAllotment

of Shares

Lock-in of 3 years

Check-points for Sweat Equity The issue must have been authorised by a

special resolution passed by the Company.

The Special resolution authorising the issue shall be valid for

making the allotment within a period of not more than 12 months

from the date of passing resolution.

The shares issued to directors or employees shall be lock-in for a period of 3 years

from date of allotment.

The shares to be issued shall be valued at a price

determined by a registered valuer as the fair price

giving justification for such valuation.

At least one year must have elapsed since

the date on which the Company had

commenced business.

Stock Appreciation Rights

SARs provide employees with cash payments equal to the

appreciation of the company’s stock over a specified duration which is

generally between the date of grant and final exercise of options.

SARs can be settled either by allotting Equity Shares, equivalent to

the amount of appreciation or by simply paying the value of

appreciation in cash.

Example

Grant of

Options

Exercise of

Vested

Options

Vesting of Options

Share price on

Grant Rs 10Share price on

Exercise Rs 100

Shares

CashAppreciation = Rs. 90/-

Phantom Stocks Phantom Stock is a form of long-term deferred compensation using the

Company shares as the measuring device for calculating the value of

the deferred compensation. The Employee is rewarded in the form of

cash corresponding to the value of the Company’s Share on the date of

maturity / exercise.

Example

Grant Vesting Exercise

Share Price on Exercise= Rs. 100

Shares Allotted

Routes for ESOP

Direct Route

Trust Route

Regulatory Regime

Companies

Act, 2013

Accounting

Implications

Stamp Laws

Income Tax

Act, 1961

Check-points for ESOP(Rule 12 of Companies (Share Capital & Debenture) Rules, 2014)

Approval of Shareholders.

All Directors excluding Promoter Director and Independent

directors.

Minimum period of one year between grant and vesting

of options.

Freedom to determine Exercise Price.

Permanent Employees of Company, Holding

Company and Subsidiary Company are covered.

Annual prescribed disclosure in Directors Report.

In case of death & permanent disability, options

granted shall vest in the legal heirs.

Options granted cannot be pledged, hypothecated or

otherwise transferred.

Work Flow of Esop

Employee

accepts the Offer

Employee

Exercises the

Vested Option

Vesting Period

Minimum gap of 1 year between grant and vesting of options

Employee gets the

shares Allotted and

becomes the

Shareholder of the

Company

Employee can sell the

Shares allotted and can get

benefit of increase in the

current market price of

shares.

Grant of

options to

Employees

Decisive Criteria What to give?

When to give?

How much to give?

Route?

How to manage?

Pricing?

Accounting?

Taxability?

Exit Mechanism?

Compliances?

Documentation?

Few Important Aspects

Who shall be awarded?

Quantum of Equity to be shared?

Industry Pay

Standard = 100Startup

Can’t afford to pay equivalent to

70%

cash

salary

30%

ESOP

Ideal

Sharing =

20% of

Capital

Persons for

Management

Persons for

Business

Development

Persons for

Administration

& Execution

Few Important Aspects

Vesting Schedule

Startup

Graded One-time

Options vest in

tranches, generally

over a period of 4 years

form the date of Grant

100% of Options

Granted get vested at

once.

Serves long-term employee association / retention motive

Few Important Aspects

Exit Opportunity

Event

Linked

Not

Linked

Funding Upon management’s discretion

Listing of Company

Merger / Acquisition

Liquidation of

Company

Can be bought back by

promoters / investors / existing

employees / any outside party

For ESOPs, there are basically 2 types of Valuations:

Accounting Valuation: This Valuation is required to amortize the Employee

Compensation Cost during the vesting period. Accordingly, the compensation

value is computed initially i.e. at the time of Grant and at the end of each

reporting period till the liability in respect of Options granted gets settled.

Perquisite Valuation: This Valuation would be conducted at the time of

Exercise of Options by the Employee to know the value of the perquisite to be

added in the Employee’s salary for the month in which he makes the exercise of

his option.

Valuation Aspects

• Employee Compensation Expense

(equivalent to Price Discount)= Market

Value- Price at which Shares are offered

Allowable Expense during the relevant

Accounting Period in which the Shares

are issued.

Suppose :

Current Value Rs.55/-

Offer price is Rs.10/-

Then Price Discount/ Employee Compensation Expense to be booked is

Rs.44/-.

REGULATORY FRAMEWORK

ICAI Guidance Note

Direct Impact on

Profit & Loss

Account

Accounting Aspects

Taxation Aspects

TAX TREATMENT

In the hands of Employee

At the time of Allotment:

Taxable Value= FMV on the date of exercise of options-Exercise Price

At the time of transfer of shares;

Taxable Value= Sales Price of Shares-FMV of shares at the time of

Exercise

In the hands of Employer

Compensation cost

ParametersEmployee Stock

Options Plan(ESOP)

Employee Stock

Purchase

Plan(ESPP)

Stock

Appreciation

Rights(SAR)

Restricted Stock

Unit(RSU)

Which helps best meet below objectives

AlignmentHigh

High Medium High

RewardHigh

Medium Medium Medium

RetentionHigh

Medium Medium High

Employee Preference High High Medium High

Comparative Analysis

FOR COMPANY FOR EMPLOYEES

Align employees’ interest with those of

shareholders;

Recruit or retain key employees;

Motivate Employees to become more productive;

Increase loyalty, job satisfaction & reduce staff

turnover;

Savings of Opportunity Cost in replacing an

Employee;

Non-cash Compensation strategy;

Tax exemptions;

Financial Rewards, linked to individual and

organizational performance or a long term savings

and ownership structure;

Improved awareness about the ‘big picture’

decisions; directions and corporate plans of the

enterprise;

An increased sense of ‘ownership’ and association

with the enterprise;

Return on ESOPs can even be higher than a

person’s annual salary;

Advantages of ESOPs

FOR COMPANY FOR EMPLOYEES

Compensation Cost in respect of ESOPs will affect

the books of accounts;

Once the options are granted, it becomes a

contractual liability of the company to allot shares to

the employees when they exercise the options

(except in case of breach & misconduct)

If the company value does not increase, the

company stock is less attractive and employees may

wish to invest their funds somewhere else, and they

might not exercise the options granted to them;

It’s a gamble;

The share price can decrease and this can

impact the value of the holding for an

employee;

The employee has all their eggs in one basket.

Essentially the employee is over exposed to the

company’s shares, so if the company does not

perform or worse goes into administration the

employees investment is lost (this problem can

be minimized by limiting the amount of salary or

shares that the employee can buy);

Dis-Advantages of ESOPs

About Us

is a venture promoted by Corporate Professionals Group, which isbest illustrated for providing widest spectrum of corporate servicesat one stop. We are recognized as a destination where all paths inhunt for corporate solutions end. Through our strong foundationsand robust growth, we have emerged as leading corporate advisorsattaining an edge in providing services at internationally competitivestandards. Our diversified team of professionals who have attainedexpertise in delivering supreme corporate services utterly justifiesour name, Corporate Professionals.

Our Offerings

Planning / Designing /

Documentation

Opinion / Advisory

Statutory Compliances

ESOP Trust Formation

ESOP Accounting &

Valuation

Administration

Implementation / Employee

Communication

We at Corporate Professionals, provides acomprehensive solution for all ESOPrelated needs of any Company.

Our Web Application, is

Our Value Added Services

specifically designed by keeping in viewthe regulatory framework under whichESOPs Function

Contact usFor further clarification,

please visit www.esoponline.in

Corporate Professionals, D-28, South Ex-Part-1, New Delhi - 110 049, India, (B): +91 11 40622231 |(D): +91 11 40622200 | (F): +91 11 40622201 | (e) info@esoponline.in

Speaker : Ms. Mohini Varshneya

AVP & Head- ESOP Services

M: +91 9971673332

E: mohini@indiacp.com