This document summarizes the legal aspects of employee stock option plans (ESOPs) for start-ups in India. It discusses the impact of the new Companies Act of 2013 on ESOPs, including exclusions of promoters from eligible employees. It also covers Securities and Exchange Board of India and Reserve Bank of India regulations, tax implications, required documentation, and corporate compliance procedures such as shareholder resolutions and disclosures. The presentation provides an overview of key definitions, rules around pricing, vesting, transfers and more for establishing legally compliant ESOP schemes for private companies in India.

1. ESOPs for Start-Ups
Indian Institute of Management - Bangalore,
October 11, 2014
NEELA BADAMI

2. Overview
• This presentation will cover some legal aspects around the
issue of employee stock option plans (“ESOP”), including:
– Impact of the new Companies Act, 2013
– Securities Exchange Board of India (“SEBI”) Regulations
– Reserve Bank of India (“RBI”) regulations
– Some tax implications
– What sort of documentation is involved?
– (The focus will be on rules applicable to private companies, and references in this
PPT must be treated as such; unless otherwise mentioned in context of SEBI)

3. Company Law around ESOPs
• For private companies
– What is an ‘Employee Stock Option’?
– Who are ‘eligible employees’?
– Rules around pricing
– Rules around ‘grant’ and ‘vesting’
– ‘Lock in’ period
– Transfer of ESOPs?
• Corporate Compliances
– Shareholders special resolution required. Separate resolutions in some cases?
– Disclosures to be made in the explanatory statement to be attached to notice
for EGM
– Disclosures to be made in Directors Report

4. “Employees’ Stock Option”
• S. 2(37) – “employees’ stock option” means the option given to the
directors, officers or employees of a company or of its holding
company or subsidiary company or companies, if any, which gives
such directors, officers or employees, the benefit or right to
purchase, or to subscribe for, the shares of the company at a future
date at a pre-determined price;

5. “Employee’’
means-a)
a permanent employee of the company who has been working in India or
outside India; or
b) a director of the company, whether a whole time director or not but excluding
an independent director; or
c) an employee as defined in clauses (a) or (b) of:
– a subsidiary, in India or outside India,
– Or of a holding company of the company or
– Of an associate company
but does not include-
(i) an employee who is a promoter or a person belonging to the promoter
group; or
(ii) a director who either himself or through his relative or through any body
corporate, directly or indirectly, holds more than 10% of the outstanding equity
shares of the company.

6. “Grant,” “Vest,” & “Exercise”
• Grant – the process of options being issued to the employee.
– Minimum period of one year between grant and vesting.
• Vesting – occurs over a schedule.
• Exercise – the process of purchasing a share once the options have
vested, by making an application for the issue of shares.
– For example, I can be granted 100 stock options today, of which 25 shall vest
each year on October 11. After October 11 each year, I can “exercise” the
option to purchase shares at a pre-determined price.

7. What “price”?
• Company is free to determine the exercise price in
conformity with applicable accounting policies, if any.
• Needs to disclose the method by which the company
proposes to value the options.

8. Can ESOPs be transferred?
• No. Pledge / hypothecation etc. also are not allowed.
• Once the options are exercised and the employee owns shares of the
company, such shares can be transferred subject to articles of
association of the company.
• The company can specify lock-in restrictions in respect of the shares
issued pursuant to exercise of the option.
• Only the employee can exercise the option. However:
– In case of untimely death, options will vest in legal heirs /
nominees.
– In case of incapacitation / disability, all options will vest in
employee on that date.
– In case of resignation/ termination, all unvested options expire.
But, employee can exercise the options granted which have
already vested, subject to applicable terms of the scheme.

9. Corporate Compliances
• Separate shareholders’ special resolution required to:
– Approve the ESOP Scheme
– Grant options to employees of subsidiaries or holding companies
– Grant options to any employee in excess of 1% of the issued
capital (excluding warrants and conversions)
– Approve any variation of the terms of the scheme; with respect to
options not yet exercised; and provided that such variation is not
prejudicial to the rights of the option holders.

10. Corporate Compliances
• Company must make following disclosures in the Explanatory
Statement attached to the notice convening the extraordinary general
meeting:
– Total # of options
– Classes of employees entitled to participate
– Appraisal process to determine employee eligibility
– Vesting requirements and period of vesting
– Exercise price / formula, exercise period and process
– Lock-in, if any
– Maximum number of options per employee
– Method of valuation of options
– Conditions under which options may lapse, for example, termination
for cause
– Time period within which employee must exercise the vested options in
case of proposed termination or resignation
– Undertaking to comply with applicable accounting standards

11. Corporate Compliances
• Board of Directors must disclose in the board’s report:
– Total number of options granted, vested, exercised or lapsed or
outstanding
– Number of shares issued, exercise price, money realised by
exercise of options,
– Variation of terms of options
– Employee-wise details of:
• options granted to Key Managerial Personnel (i.e. CEO / MD /
Manager / Company Secretary /Whole Time Director / CFO)
• Any other employee who receives a grant of options in any one
year ≥ 5%or more of options granted during that year.
• Identified employees who were granted options ≥ 1% of
issued capital (excluding outstanding warrants and
conversions) of the company at the time of grant

12. Corporate Compliances
• Maintain a Register of Employee Stock Options in
Form No. SH6,
• At the Registered Office or such other place as the
board may decide,
• To be authenticated by the company secretary or
any other authorised person.

13. Form No. SH-6
Register of Employee Stock Options
[Pursuant to clause (b) of sub-section (1) of section 62 of the Companies Act, 2013 and rule
12(10) the Companies
(Share Capital and Debentures) Rules 2014]
Name of Company
Registered office address
Date of special resolution …………….
Sl. No. Name of the
grantee
Number of
options granted
Date on which
options vested
Exercised period
1 2 3 4 5

14. Date on which options
exercised
6 7 8 9
Folio No. of
Register of
members having
respective entry
Any variation of
terms of the
scheme and its
effects
Options exercised Exercise price Number of shares
Lock in period, if
any
Option lapsed, if
any
Signature Remarks
15 16 17
Total number of
options in force
arising as result of
exercise of option
Amount forfeited/
refunded if option
is not exercised
10 11 12 13 14

15. Impact of the new
Companies Act, 2013
• Issuance of shares to Promoters has become unwieldy,
since for the first time, sections on ESOPs have been
introduced in the Act. ‘Promoters’ are specifically
excluded from the definition of eligible employees.

16. ESOPs – Practice Notes
• What are the workarounds?
– Issue Sweat Equity Shares (requires some structuring of
the ‘value add’ of the promoters; there could be tax /
accounting implications; a valuation report is needed)
– Issue Warrants (this would attract Preferential Allotment
+ Private Placement compliance)
– Issue ESOPs to Employees in their capacity as directors
(as long as they don’t hold more than 10%
shareholding)
– Is a Promoter, really a ‘Promoter?’ or, to put it
philosophically, who is a Promoter? (see next slide)

17. Who is a ‘Promoter’?
• The 1956 Act did not define a ‘promoter,’ but the 2013 Act,
does, as follows. “Promoter” means a person—
(a) who has been named as such in a prospectus or is identified
by the company in the annual return referred to in section 92;
or
(b) who has control over the affairs of the company, directly or
indirectly whether as a shareholder, director or otherwise; or
(c) in accordance with whose advice, directions or instructions
the Board of Directors of the company is accustomed to
act (Provided that nothing in sub-clause (c) shall apply to a
person who is acting merely in a professional capacity);

18. What is ‘control’?
“control” shall include the right to appoint majority of the directors
or to control the management or policy decisions exercisable by a
person or persons acting individually or in concert, directly or
indirectly, including by virtue of their shareholding or management
rights or shareholders agreements or voting agreements or in any other
manner.
Hence the question, is a ‘promoter’ really a “promoter”?! At least to
avail the benefit of ESOPs!

19. Issue of Shares to
Consultants /Advisors
• Made procedurally difficult since any issuance has to
comply with private placement, preferential allotment,
rights issue, ESOP, or sweat equity shares!
• There are challenges with each of these routes.
• As a matter of practice, most PLCs have abandoned the
practice of issuing shares instead of cash, because of the
procedural compliances involved.
• Rights Issue is perhaps the best method.

20. ESOPs in Listed Companies
• The new Companies Act, 2013 has imported whole-sale
most of the compliances required of listed companies.
What is the wisdom of this?!

21. Foreign Exchange Issues
• Regulation 8 of FEMA 20 allows for Indian companies
to issue ESOPs to its employees or employees of it’s
JVs / WOS who are resident outside India, provided:
– Compliance with SEBI Rules or Companies Act as
applicable
– Face value of shares does not exceed 5% of paid up capital
– Reporting to RBI

22. Indian residents and foreign ESOPs
• Indian residents can acquire shares under cashless Employees Stock Option Programme
(ESOP) issued by a company outside India, provided it does not involve any remittance
from India;
• Indian residents can also purchase equity shares offered by a foreign company under its
ESOP Schemes, if they are employees, or, directors of:
• an Indian office or branch of a foreign company, or,
• of a subsidiary in India of a foreign company, or,
• an Indian company in which foreign equity holding, either direct or through a
holding company/Special Purpose Vehicle (SPV) irrespective of the percentage of
the direct or indirect equity stake in the Indian company.
Provided:
• The shares must be offered by the issuing company globally on a uniform basis,
• an Annual Return (Annex B) is submitted

23. Taxability of ESOPs
Two stages of taxability in the hands of the employee as follows:
• The first stage is when the options are exercised by the employee. The benefit,
which is the difference between the fair market value (“FMV”) of the shares on
the date of which the option is exercised and the amount at which the options were
granted to the employee, is treated as a perquisite as per Income Tax Act, 1961
(the “Act’).
• The second stage is when the shares are sold or transferred by the employee in
which case the difference between the sale consideration and the FMV of the
shares would be treated as capital gains and will be subject to capital gains tax.
• In the hands of the Company issuing the ESOPS, it is allowed to claim ESOP costs
as deductions.

24. Documents involved
• Board Resolutions
• Shareholders Resolutions
• Option Agreement / Letter of grant
• Letter of Exercise
• Share Certificates
• ESOP Trust and related documents (Trust
Deed) – Optional

25. Questions?

26. Thank you!

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