6 Mistakes that Prevent ESOPs from Being Successful
ESOP creation and administration can create issues in talent acquisition, motivation and retention.
An ESOP is an employee benefit plan which offers employees ownership interest in the organization. Companies offer ESOPs to employees with an objective to retain them for long-term, and also to make them the stakeholders of their company. Under an ESOP scheme, employees are granted options, which allows them to buy the stock at a rate below the prevailing market value of the stock or the employee is provided certain percentage of his / her remuneration in stocks of the company.
Trust route is a method of issuing shares pursuant to the adoption of ESOP scheme. An ESOP Trust is specifically created and registered for the purpose of implementing ESOP Plan. A company drafts a scheme and gets it approved from the members of the company.
Simultaneously, an ESOP Trust is formed as per the provisions of Indian Trust Act, 1882 and registered to act as an intermediary between the company and employees. As and when options are exercised by the option holders, the ESOP Trust is responsible for issuing shares to employees.
Under the ESOP Trust route, the company does not have to dilute its existing capital base and therefore the ESOP Trust route mechanism is preferred by the listed companies for secondary market acquisition of shares.
The exit route for the employees is also easier in case of ESOP Trust mechanism than in case of ESOP Direct route structures. Thereby, it provides liquidity to the employees once the options are exercised by them.
There are three parties to the ESOP Trust formation which are mentioned below:
The directors, Key Managerial Personnel and their relatives of the company, its holding, subsidiary company, or associate company Any person beneficially holding more than 10% of the paid-up share capital of the company.
There could be numerous factors that may drive companies to use the ESOP Trust structure for management of its employee stock options, some of them are as under
There are some aspects which need to be considered by the company before deciding whether to issue ESOP through direct route or to form an ESOP Trust. Some of the key aspects are mentioned below:
There are several factors that must be kept in mind before adopting a Trust structure, some of these include –
ESOPs can be considered as a long-term strategy to retain employees as it gives a sense of ownership in company. A number of start-ups in initial years requires support and care to flourish their business - ESOPs help them in meeting targets in case of cash crunch.
Formation and regulation of ESOPs requires lots of consideration. Both Direct route and Trust route have their advantages and complexities and therefore a prudent decision would need to be undertaken keeping in mind the objectives and requirement of the Company.
Authored by Smita Goel, Partner-Tax, Barkha Tahiliani, Principal Associate-Tax and Tanupriya Goyal, Senior Associate-Tax
For any ESOP related query or assistance in structuring, implementing, or managing your ESOP plans, reach out to us at: esop@algolegal.in This material and the information contained herein prepared by Algo Legal is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). Algo Legal is not, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision. Algo Legal shall not be responsible for any loss whatsoever sustained by any person who relies on this material.