Key Components of an ESOP Scheme

Written By:
Team Qapita
Calendar
September 5, 2024

Broadly speaking, an Employee Stock Option (“ESOP”) Scheme is an embodiment of objectives, guidelines and rules. A note worthy thing in respect of ESOP is that it is a regulated instrument whether one talks about a listed or an unlisted company at whatever stage of business.

If one starts to identify the key components of an ESOP Scheme, the first thing considered is the relevant laws as to what is allowed and what is not, which becomes the four corners of the ESOP Scheme. Any articulation on ESOP Scheme designing is subject to these pre-requisites of law. The articulation is all about the structuring of the ESOP Scheme which determines the specifics of key components, which is broadly based on commercial understandings as to “why” and “how” an ESOP Scheme shall be implemented.

Following points pose as key components of an ESOP Scheme or of any of its variants like Stock Appreciation Rights Scheme (“SAR Scheme”), Restricted Stock Unit Scheme (“RSU Scheme”) or even a Phantom Scheme:

1. Primary objective(s): Identification of objectives viz reward / motivation for retention, performance, etc.;

2. Mode of settlement: By way of cash, equity shares or both;

3. Source of shares: In case of mode of settlement is equity shares, whether primary or secondary;

4. Route of implementation: Directly or through trust route;

5. Coverage/ selection criteria: Levels/ bands of employees those may be considered for grant;

6. Individual allocation: Vital to retain and motivate the talents;

7. Identifying the administrator: The nodal forum for all decision making under the scheme;

8. Vesting parameters: Minimum and maximum vesting period, vesting schedule and vesting conditions;

9. Exercise parameters: Exercise price which an employee needs to pay and the exercise period within which ESOPs are required to be exercised;

10. Employee separation: Treatment of ESOPs in case of separation for any reason;

11. Other key terms: Taxation on ESOPs, clarification as to employee’s right as an ESOP Holder, way forward in case of any corporate action namely bonus issue, rights issue, merger, etc., protection from data privacy and jurisdiction.

Last, not the least

In addition to above, a vital and tricky component of an ESOP Scheme for an unlisted company is provisioned on monetization (or what is popularly referred to as “exit” or “liquidity”) of ESOPs or ESOP shares. ESOP rule for unlisted companies is silent on this which provides leeway for the best possible structuring as to when, how, and to what extent ESOPs or ESOP shares can be monetized. Further, in case shares are issued in a closely-held company, what provisions can be made to minimize or avoid potential risks on account of shares being held by an employee, an ex-employee or a group thereof.

Fine-tuning of these key components in specific terms generally requires an analysis with reference to the business plan of a company with a view to check if these (i) are conducive to the ESOP Scheme objectives, and (ii) create a win-win for all stakeholders. Thus, these key components remain the same for all companies but their specifics usually differ, and may significantly differ in certain cases even within a sector.

Team Qapita

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