Employee stock option plans (ESOP) should help in building a skilled workforce, essential for company success in the modern world. Employee stock options have gained significant popularity in India thanks to the thriving ESOP startup culture, making them increasingly advantageous.

What is ESOP?

An Employee Stock Option Plan (ESOP) is a method of rewarding key employees for their performance. It grants employees the right to purchase or subscribe to company shares at a future date at a pre-determined price.

Employee eligibility for ESOP

The below table gives gist of Eligible employees for ESOP:

Sr. No. Type of employee Eligible per company’s Act  

(Yes/No)

Eligible employee as per SEBI

(Yes/No

1. Permanent employee of the company (Co.) or subsidiary Co. in India or outside India Yes Yes
2. Part-time employees, consultants, advisors, mentors No No
3. Directors, investor/advisor on the board of directors Yes* Yes*
4. Board observer or an independent director No No
5. Employees of associate company No Yes
6. Employee who is either a promoter or a person belonging to promoter group No No
7. The founders/promoters of DPIIT recognized startups Yes (subject to conditions) Yes (subject to conditions)
8. Future employee Yes Yes
9. Foreign employee Yes** Yes**

* Should not either himself or through his relative or through anybody corporate, directly or indirectly hold more than 10% of outstanding equity shares of the Co.

** Subject to FDI guidelines and above eligibility.

Other versions of employee ownership include, direct-purchase programs, stock options, restricted stock, phantom stock, and stock appreciation rights.

Key terms that you should know about in ESOP

Grant date – Employer gives the employee the option to own shares of the company at a later date (Vesting date).

Vesting date – Vesting date is when the employee is entitled to buy options on fulfillment of conditions

Vesting period – The period between the grant date and vesting dates (minimum 1 year)

Exercise period – Once the vesting of shares is done, the employee now has a right to exercise the option within a certain period i.e. exercise period.

Exercise Date – The date on which the employee exercises the option to buy shares of the company.

Exercise Price – The price on which employees exercise the option is the exercise price. Once the payment of the exercise price is made, the shares are issued to the employee.

Life cycle of ESOP

Below is the flow of an Employee Stock Option Plan (ESOP), from policy execution to employee exercise: 

Documents required for ESOP as per the companies Act

  • ESOP scheme
  • Minutes of a board meeting
  • Minutes of the general meeting
  • A resolution, accompanied by an explanatory statement, that approves the ESOP.
  • Boards report
  • PAS – 3 MGT- 14.
  • Valuation report from registered valuer at the time of grant of the option and at the time of determining Fair market value while exercising the option from Merchant Banker.

Pricing criteria

The companies have the flexibility to determine the exercise price for ESOPs. The exercise price shall never go below the face value of the shares. ESOP can be issued at a discount or a premium. Different exercise price can be done for different category of employees.

ESOP Trust Structures

How does an ESOP Trust work?

An ESOP Trust is a private entity established and registered to administer an ESOP plan. Here’s a typical flow of how an ESOP trust operates.

Exit Option

Employees holding publicly listed shares can sell their ESOPs in the open market. ESOP Exit in the case of private and closely held companies is a bit challenging as their stocks are not publicly tradeable. Below are the commonly used methods in private and closely held companies for ESOP exits.

Methods Description
IPO- Initial Public Offering Company may get their securities listed on the stock exchange for the first time.
Secondary transfer Transfer of shares to existing shareholders, promoter group or any other third person at the instruction of the management
Buy Back Company has the option to buy back the securities issued to the employee in lieu of cash or other consideration. The detail covered in the next article on Buy-back of shares.