Employee Stock Ownership Plans (ESOPs) – For Startup Founders in India

Employee Stock Ownership Plans (ESOPs) – For Startup Founders in India

Start-ups comes with plenty of difficulties by its own as starting fresh means dealing with problem to secure a good place in the market with effective productivity. Government of India is also working in “Make in India” plans for the development and growth of nation and gives a lot subsidy and relaxation in order to promote the entrepreneurship skills in the youth of India.

Employees are the most important part of any organisation and most importantly for start-ups that are in a keen need of good employees and it is essential to retain them in the business, the ESOPs are one of the way to keep the talented employees satisfied and retained them with the organisation for long time.

What is ESOPs?

In simple terms it means giving the employees ownership rights in the organisation by allowing them to purchase corporate shares at reduced price. This works as a motivation to the employees to work harder in the organisation and it is the prime requirement of any start-up i.e. hard work with passion. It usually included in retirement and employee benefit plan where employees own their own interest. They are offered as compensatory benefits to the employees to boost the productivity of start-ups.

How much amount of ESOP can be dispersed among the employees?

Although it is the difficult choice for the founder of start-up to determine the exact share, which is to be distributed among employees. To offer ESOPs the founder needs to create a pool by contributing their own equity in a definite proportion. The distribution of ESOP will be inversely proportional to the growth of the organisation. At initial stage the focus of the start-ups are on expansion and growth. Resultantly, there is a need to keep the talented employees in the organisation. With the growth of the company the size of ESOP pool will shrink and be replaced by the cash rewards and other monetary or non-monetary benefits. Astoundingly, it comes into mind that why this policy cannot be implemented at the initial stage inspite of ESOP pool and giving ownership rights to the employees? The answer to this question is very obvious that there is a lack of capital and cash flow in the market at foundation stage and being the major factor in growth of company the talented human capital cannot be sacrificed.

How to make-up ESOP?

To begin, the company needs to establish employee stock ownership plan as follows:

Vesting – The stock should be distributed in progressive manner. The general vesting period is three to four years.

Establish ESOP Pool- The Company can initially start with the less amount of equity i.e. 5-10%, and can increase with the growth of the company or according to the need of human power. It is suggested that it should be added in the shareholder agreement with brief facts. To avoid any hassle in the future it is recommended that agreement must be drafted by the legal attorney or under the guidance of legal advisor.

Cliff Period- It refers to the period after which an employee becomes fully vested. In general, 12 months vesting period is practiced for ESOP vesting.

Valuation Certification: The Company must create valuation report as it is essential in accounting and auditing purpose. Additionally, the company needs to mention the striking price of the share in the said report.

Approval from Directors: As soon the ESOP scheme is prepared, it needs to be presented before the Director for final approval. As the scheme is not approved at early stage, the company is not able to provide shares to the early employee at promised price.

Shareholder’s Consent: According to the provisions of Companies Act, 2013 (Act), the consent of the shareholders is mandatory as mentioned in the  extraordinary general meeting which results in addition of Section 62(1)(B) of the Act. In ambit of 30 days from the board and shareholder resolution, the company with the help of designated member have to file them with the registrar of company physically or electronically.

Initiate Distributing ESOP: After completing all the procedure and permission the company can start awarding their employees with the scheme.

The company needs to prepare the ESOP scheme for the growth of company and employees. This kind of motivation leads in great enthusiasm in employee and eventually helps in hard work and concentration. It can be concluded by studying the whole procedure that steps involved in preparing ESOP is complex and need due diligence to avoid future consequences therefore, it is advisable to seek legal advice on the various stages.

-Surbhi Singla

Associate at Aggarwals & Associates, Mohali.