The complete lowdown on ESOPs for startups

By Tanvi LoondIndia is the third largest startup ecosystem in the world and has attracted global investor attention as is evident from the expanding list of Indian unicorns. Small businesses with strong founding teams are able to raise funds at a very early stage, despite having no revenue. The hope to transform from a small business to a unicorn drives these entrepreneurs and schemes such as Employee Stock Option Scheme (ESOS) ensure that everyone in the company is striving for the same goal, that is, stock value appreciation.All SMEs/startups, that is, unlisted companies must follow the rules laid out in the Companies Act 2013 for issuances of employee stock options. In this article we have listed key features of ESOS for unlisted companies.An Employee Stock Option Plan (ESOP) is essentially an incentive, granted to an employee, director or officer to buy or subscribe to the shares of the company at a pre-determined price in the future. In this way, grantees are offered equity compensation instead of/in addition to the remuneration. The benefit of ESOPs is that it allows grantees to have a stake in the company which directly results in greater loyalty and motivation while aligning the incentives of various stakeholders.EligibilityPermanent employees, directors and officers are eligible to receive an option under an ESOP scheme. However, the following individuals are not eligible to participate in the scheme:an Independent Director,an employee who is a promoter or belongs to the promoter group,a Director who directly or indirectly holds more than 10% of outstanding equity sharesESOS priceThe company granting an option under ESOS has the freedom to determine the exercise price subject to accounting policies and regulations. The pre-determined price at which an employee can exercise the option is called strike price or exercise price.If the price of the stock increases, the employee gains by exercising the option at the strike price, which is below the current stock price. However, If the stock goes down, the option will be worthless, and the employee will not incur a notional loss which is the case with normal stock ownership. Simply put, the employee benefits from the gains when the stock price rises but loses nothing in case the company is unsuccessful.ESOS termThe term of the ESOS is called the vesting period. It is the time period that a grantee must wait in order to exercise the option to buy the shares. ESOPs may vest in a phased manner, that is, 5% in the second year, 5% in the third year and so on.Taxation of ESOPThe value of the employee stock option is taxable as a perquisite in the hands of the employee. The value of the ESOPs is calculated as follows:Fair market value (FMV) of shares on the date of exerciseLess : Exercise price actually paid by the employeeLet’s say, Raj was granted ESOPs at an exercise price of Rs 1,000 per option. The FMV on the date of vesting is Rs 4,500 while the FMV on the date of exercise is Rs 5,000, the taxable value in Raj’s hands will be Rs 5,000- Rs 1,000 = Rs 4,000.Capital gains tax on ESOPIn case the employee makes a subsequent sale of such shares, the gain on such sale will be taxed as capital gains. The cost of purchase for computing capital gains would be the FMV on the date of exercise of the option.Compliance requirements for issuance of ESOP1. Approval of shareholders of the company shall be obtained by passing a special resolution2. The company shall make the following disclosures in the annexure to the notice for passing a special resolutionTotal number of stock options to be grantedIdentification of classes of employees entitled to participate in the ESOSAppraisal process for determining the eligibility of employees to the ESOSRequirements of vesting period and period of vestingMaximum period within which the options shall be vestedExercise price and the formula for arriving at the sameExercise period and process of exerciseLock-in period, if anyMaximum number of options to be granted per employee and in aggregateThe method which the company shall use to value its optionsThe conditions under which option vested in employees may last, for example, in case of termination of employment for misconductSpecified period within which the employee shall exercise the vested options in the event of a proposed termination of employmentA statement to the effect that the company shall comply with the applicable accounting standards3. The company shall obtain approval of shareholders by passing a separate resolution in case ofGrant of option to employees of subsidiary or holding companyGrant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital of the company at the time of grant of option4. The company may vary the terms of ESOS not yet exercised by the employees by passing a special resolution, provided such variation is not prejudicial to the interest of the shareholders.5. The company shall maintain a Register of Employee Stock Options in Form SH-6.(The writer is the Founder and CEO, Insta C.A (www.InstaCA.in) . Insta C.A. is an online tax and accounting services for SMEs and startups. For more information contact info@instaca.in and their twitter handle is @InstaCA1.)

from Economic Times https://ift.tt/2jJVqKf