Separation of ownership from management has been one of the principal foundations of corporate law. In this context, the idea of granting your employees stock options aims at bridging the gap between ownership and management, by giving the employees not just monetary compensation but also a sense of ownership through stock options.
There is significant literature on employee stock options (ESOPs) for
public limited companies in India, but little has been written about
how they can be used by private limited companies.
The issue of granting ESOPs acquires particular significance in the
context of start-ups who do not offer significant compensation to their
employees/ consultants but wish to offer ESOPs to retain talent and to
also give them a sense of ownership and belonging. Set forth below is a
summary of key issues to keep in mind while instituting an ESOP plan:
(a) Legal requirements: There are no specific guidelines/
rules or regulations under the Companies Act, 1956, that deal with
employee stock option plans of a private limited company. Critical
issues which arise in instituting an ESOP plan have been addressed
(b) Who can the options be granted to? While technically there
is no prohibition to grant options to ‘promoters’ (persons who are in
overall control of the company) they should ideally be excluded, because
it is possible for them to get additional shares in the company through
a preferential allotment. Similarly, there is no requirement that ESOPs
should only be given to full time permanent employees of the company.
(c) What should be the ceiling for ESOP grants? There is no ceiling prescribed in law, however, a limit of 10-15% of the paid up capital is typically the market practice.
(d) Market price of the shares: Since in private limited
companies, there is no market for the shares it is impossible to arrive
at a valuation of the equity shares, unless they are valued by
independent valuers, which exercise may itself be expensive. A possible
solution is to use the book value of the shares.
(e) Disclosure requirements: A great step forward is the
creation of an ESOP policy plan document and circulating the same to the
employees. This increases transparency and creates trust among the
employees in favour of the company. Typically plan documents contain
details such as vesting schedule, lock-in requirements and eligibility.
(f) Enforcing the ESOP plan: While there is no one rule on who
should institute the ESOP plan, ideally it should be enforced by
persons who are not beneficiaries of the plan or are in no way
interested in the results of the plan. Whilst, there are no independent
directors in a private limited company, a possible solution is
institution of the plan by independent trustees. If that however,
becomes too cumbersome, then the Board of Directors could be responsible
for the instituting the plan, provided that they are not beneficiaries
of the plan.
Conclusion: As a start-up, ESOPs are probably on your mind as
you consider bringing in the best talent to scale your business. While
we have outlined the rules above which apply to you from a legal
perspective, the most important rules when it comes to giving ESOPs are
equity and fairness. As long as the plan you draft is fair, it is almost
certain to get approved by the Court if, god forbid, a dispute should
[About the author: Contributed by Hrishikesh Datar, founder of vakilsearch.com, online legal services provider (Legal Advice, Legal Documents & more.]
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