EMPLOYEE STOCK OPTION PLAN

1. ESOPs
By
Dr. H.S. ABZAL BASHA, M.B.A., Ph.D., L.L.B.
Assistant Professor,
Department of Management Studies,
G. Pullaiah College of Engineering & Technology,
Kurnool.
(EMPLOYEE STOCK OPTION PLAN)

2. Increasing Popularity Of ESOP
 Determining innovative retention program
 ESOP is one of the most popular employee retention and motivation program
 In a poll conducted by Business world in India
63% companies have confirmed having an ESOP program or planning to have one
in next 12 months

3. Employee Stock Option Plan
 Employee Stock Option Plan (ESOP)
is a plan through which a company grants an option to its employees to
acquire shares at a future date and at a predetermined price .

4. Objective Of ESOP
Reward
Performance
Enhance
Retention
Attract
Talent
Reward
Loyalty

5. Objective Of ESOP
Sense of belonging and
ownership amongst the
employees
Retirement
plan
Motivates the
employees
Improve
shareholders'
value
Wealth
creation for
employee

6. Whom to give ?
Senior
Middle
Junior
50-70%
30-50%
0-20%
ESOP
Allocation
Management
Structure

7. Incentive Mechanism
• Employee Stock Option Plan(ESOP)
• Employee Stock Purchase Plan (ESPP)
• Share Appreciation Rights (SAR)

8. Employee Stock Option Plan
A stock option is the opportunity, given by employer, to own a
certain number of shares of your company's common stock at a pre-
established price, known as the grant price, over a specific period of
time, known as the vesting period.

9. Terms used in an ESOP
 Grant Date
 Option Price
 Vesting Date
 Exercise Period

10. Example
 Shenoy Solutions, an IT company.
 Has 100,000 shares currently priced at Rs. 10
 The company offers an employee Girish on
1st November 2008 (Grant Date ) , option of 1000 shares at Rs. 10 (Option
price), after two years (Vesting period).
 After two years i.e 2010, the price of the share is Rs. 40, and Girish exercises
the option(Exercise Period) he pays Rs. 10,000 and the
company issues 1000 shares.

11. Work Flow Of ESOP
HR creates option plan Employee accepts
option plan
Employee
exercises
options
HR approves
exercise
transaction
HR collects
payment
Shares are issued
into the employees
account
Vesting
period

12. Salient Features Of ESOPs
 Employees can acquire shares at a pre-determined price
 Exercise of option plan is subject to vesting period
--- Minimum period of one year between grant and vesting as per SEBI
Guidelines
 Right to dispose of shares subject to lock-in-period as may be determined by
the company

13. Rules and Regulations
 By Companies Act-Issue of stock options requires approval of shareholders by
way of a special resolution as per section 81(1 a).

14. EMPLOYEE STOCK PURCHASE PLAN
 Employees are given the right to acquire shares of the company immediately ,
not at a future date as in ESOP ,at a price lower than the prevailing market price
.
 Shares issued are subject to lock-in period , as a result the employee cannot sell
the shares and or the employee has to continue with the employer for a certain
number of years.

15. Salient Features of ESPP
Companies issue shares to employees
 Price could be at a discounted rate or at market rate
 Lock-in period of one year for listed companies as per SEBI (ESOP) guidelines
- No lock-in where ESPP is part of public issue and
-Shares are issued at same price as in public issue
 Free transferability after lock-in period

16. Share Appreciation Right(SAR)
 Under this scheme , no share are offered or allotted to the employee .
 The employee is given appreciation in value of shares as an incentive or
performance bonus.

17. Salient Features Of SAR
 Equity linked performance rewards
 Realization of appreciation without cash investment by employees
 Employer to pay out cash

18. Increasing Popularity Of ESOP
 Determining innovative retention program
 ESOP is one of the most popular employee retention and motivation
program
 In a poll conducted by Business world in India
63% companies have confirmed having an ESOP program or planning to have
one in next 12 months

19. EMPLOYEE STOCK OPTIONS
 Employee Stock Option Plans/Equity Incentive Plans (commonly referred to as ESOPs) are one of the
most important tools to attract, encourage and retain Employees. It is the mechanism by which
employees are compensated with increasing equity interests over time.
 Company grants an option to its Employee to acquire Equity Shares of the company at a future date
and at predetermined price.
 There is no limit on quantum of ESOPs to be issued to employees
Owners Employees

20. WHY ESOPs?
Attract, Reward, Motivate and Retain Employees
Enhances job satisfaction
Deferred compensation strategy
Good retirement benefit plan
Employee aligns with company’s goals

21. RESTRUCTURING MODES UNDER ESOP
Employee Stock
Option Plans
(ESOP)
Stock Appreciation
Rights – Cash Settled
(SAR-Cash Settled)
Stock Appreciation
Rights – Equity
Settled
(SAR-Equity Settled)
Employee Stock
Purchase Plan
(ESPP)
Restricted Stock
Units
(RSU)

22. MAJOR TERMS TO UNDERSTAND
Grant: Offering of ESOP Options from Company to Employee
Vesting: Process through which employee becomes eligible to exercise options
Exercise: When employee applies to Company for getting shares allotted

23. EMPLOYEE STOCK OPTION PLAN (ESOP)
It is a right offered by a company to its employees to take equity shares of company at
discounted price.
Grant of
options
Vesting of
options
Exercise of
Vested options
Allotment of
Shares
Example of Companies Offering ESOPs:

24. EMPLOYEE STOCK PURCHASE PLANS (ESPP)
It allows Employee to purchase Company’s shares, often at a discount from Fair Market
Value.
Offer of shares
at discounted
price
Allotment
of shares
If accepted by the Employee
Example of Companies Offering ESPPs:

25. RESTRICTED STOCK UNITS (RSU)
Employee is awarded with the shares subject to fulfillment of certain underlying conditions.
Underlying Conditions like:
- Target / Revenue
- Performance based etc.
If Condition fulfilled
Grant of
options
Vesting of
options
Exercise of
Vested
options
Allotment
of shares
Example of Companies Offering RSUs:

26. STOCK APPRECIATION RIGHTS (SAR)
In case of SARs employee gets the benefit in the form of cash / equity which is the
difference between the date of grant and final exercise of options.
Grant of
Options
Exercise of
Vested
Options
Vesting of Options
Share price on Grant
Rs 10
Share price on
Exercise Rs 100
Shares
Cash
Appreciation = Rs. 90/-
Example of Companies Offering SARs:

27. ESOP IMPLEMENTING MODES
Direct Route
Trust Route

28. DIRECT ROUTE
Direct
Route
Company Employee
1 Options to buy shares
2 Exercise of options
3 Issue of shares

29. TRUST ROUTE Trust
Route
Employee
Welfare
Trust
Company Employee
1
Grant of Loan for Payment of
subscription Money
4
Exercise of options
6
Repayment
of Loan
5
Transfer of
Shares
3 Issue of options
2 Direct Issue of Shares

30. FAQs- TRUST ROUTE
1. Does giving loan to Trust for ESOP purpose, by a Company attracts Sec. 186 of Companies Act,
2013?
No. It is allowed under Sec. 67 of CA, 2013, only if it is given for ESOP purpose.
2. What are the tax implications in case of Trust Route?
- On Company : No tax liability
- On Trust : Capital Gain / Loss at the time when Trust transfer shares to employees
- On Employees : Perquisite tax at the time of exercise of options
Capital Gain tax at the time of sale of shares
3. In which category the Trust is shown in the SHP of listed company?
Non-Promoter Non-Public Category

31. FAQs- TRUST ROUTE
4. Who can become the Trustee of ESOP Trust?
- For Private Companies : Anyone can be a Trustee
- For Public Unlisted & Listed Companies : Anyone can be a Trustee except a person:
1. is a director, key managerial personnel or promoter of the company or its holding,
subsidiary or associate company or any relative of such director, key managerial personnel
or promoter; or
2. beneficially holds ten percent or more of the paid-up share capital of the company.

32. SEBI’s INFORMAL GUIDANCE: In the matter of Capital Trust Ltd.
- SEBI held that, since the Trustees do not have any voting rights on the Equity Shares held by an ESOP
Trust,
- Therefore, the shares held by the Trust will not be counted as part of company’s capital for the
purpose of determining the voting rights as per the SEBI (SAST) Regulations, 2011.
Category No. of Shares Percentage No. of Shares Percentage
Promoter1 24 24% 24 25.26%
Promoter2 46 46% 46 48.42%
Public 25 25% 25 26.32%
ESOP Trust 5 5% 0
Total 100 100% 95 100

33. COVERAGE OF EMPLOYEES
Defined under Regulation 2(f) of
SEBI (SBEB) Regulations, 2014
Employees
Covered
Not Covered
Of Company,
its holding &
subsidiaries +
Foreign
employees

34. FAQs- COVERAGE OF EMPLOYEES
1. Coverage of Group Company employees?
- Holding Company : Covered – Separate approval of shareholders required
- Subsidiary Company : Covered - Separate approval of shareholders required
- Associate Company : Cannot be covered
- Joint Venture : Cannot be covered
- Group Company : Cannot be covered

35. WHAT COMPANY’S SEE WHILE GRANTING ESOPs
Loyalty
Performance
Designation
Present & Potential Contribution
Opportunity Cost

36. REGULATORY FRAMEWORK
Unlisted Company
• Companies Act, 2013 +
Rules
• Income Tax Act, 1961
When Foreign
Employee are covered
(Applicable for Listed +
Unlisted)
• Foreign Exchange
Management Act, 1999
Listed Company
• SEBI (SBEB) Regulations,
2014
• SEBI (LODR) Regulations,
2015
• SEBI (PIT) Regulations, 2015
• Income Tax Act, 1961

37. FAQs - FEMA
1. What are the FEMA provisions that are applicable on issuing ESOPs to foreign employees?
- Now there is no limit on %age of capital which can be issued as ESOP to foreign
employees.
- Companies need to adhere the provisions of CA, 2013/ SEBI Regulations, as the case may
be, while issuing ESOPs outside India.
- Companies falling under Approval Route need to obtain prior approval for issuing ESOPs
- Form ESOP is required to be filed with AD-Bank within 30 days of Grant of Options
- Form FC-GPR to be filed with AD-Bank within 30 days of allotment of shares

38. HOW TO ISSUE ESOPs?
General Meeting
Grant of options
Exercise of option by an employee
Allotment of shares to the Employees
Vesting period
Board Meeting

39. PRICING CRITERIA
BASE FOR PRICE
Market price, one day before the date of Grant
A price calculated on the basis of
valuation done upon Grant.
- Companies are free to decide the Exercise price,
- discount / premium over it however,
- the Exercise price shall never go below the Par Value of Shares
Listed Company
Unlisted Company

40. • Employee Compensation Expense (equivalent to
Price Discount)= Market Value- Price at which
Shares are offered
REGULATORY FRAMEWORK
Ind-As 102 / ICAI Guidance Note 18
Allowable Expense during the relevant
Accounting Period in which the Shares are
issued.
Example :
Current Value Rs.55/-
Offer price is Rs.10/-
Then Price Discount/ Employee Compensation Expense to be booked is
Rs.44/-.
Direct Impact on Profit &
Loss Account
ACCOUNTING ASPECTS

41. TAX TREATMENT
FOR EMPLOYEES
TAX
TREATMENT
In the hands of
Employee
At the time of Allotment:
Taxable Value= FMV on
the date of exercise of
options-Exercise Price
At the time of transfer of
shares;
Taxable Value= Sales Price
of Shares-FMV of shares at
the time of Exercise
Example : (Perquisite Tax)
FMV on Exercise :- Rs.100/-
Exercise Price :- Rs.10/-
Perquisite Value :- (Rs.100 –
Rs.10) = Rs.90/-
Tax @ Rs.20% :- Rs.18/-
Example : (Capital Gain Tax)
Sale value :- Rs.120/-
Holding period less than 1 year
Short Term Capital Gain
Gain Value: - (Rs.120– Rs.100) =
Rs.20
Tax @ 15% :- Rs.3/-

42. TAX TREATMENT FOR COMPANY
Company has no tax liability, it has to book Compensation Cost in its P&L Account
- Point of Calculation : Grant
- Period of Booking : Over vesting period
Decided Judgements:
CIT vs. Lemon tree Hotels Ltd. , August, 2015: It was decided that expense incurred by employer is allowable
& can be debited from P&L account of company.
CIT(A) vs. People Interactive India Pvt. Ltd. , October, 2015: It was decided that discount under ESOP is in the
nature of employee cost and hence is deductible during the vesting period.

43. COMPARATIVE ANALYSIS
Parameters
Employee Stock
Options Plan(ESOP)
Employee Stock
Purchase
Plan(ESPP)
Stock Appreciation
Rights(SAR)
Restricted Stock
Unit(RSU)
Which helps best meet below objectives
Alignment with
Company Goals
High
High Medium High
Reward
High
Medium Medium Medium
Retention
High
Medium Medium High
Employee Preference High High Medium High

44. ESOP & MANAGERIAL REMUNERATION
Whether ESOP granted to a Director is included in his Managerial Remuneration?
- Yes
- ESOP is a perquisite & perquisites are included in remuneration. Hence ESOP
becomes part of MR of a Director
- Trigger point is exercise of options
- Example: Perquisite Value – Rs.200/-
Number of Options Exercised – 50,000
Total Perquisite value – Rs.1,00,00,000 (Added to the MR of the year of exercise)
Limit on MR in a Financial Year – 5% of Net Profit
Rs. 1,00,00,000 is exceeding the limit – then CG approval is required.

45. ESOP & INSIDER TRADING REGULATIONS
Restrictions of Trading window closure
On Exercise :Not Applicable
On Sale : Applicable
Restrictions of Contra-trade Not Applicable
Requirement of Pre-clearance
On Exercise :Not Applicable
On Sale : Applicable
on Designated Employee having UPSI
Disclosure Requirements Applicable

46. EXIT MECHANISM – FOR UNLISTED CO.
Employee can surrender his shares at any of the following events:
 Listing of Company
 Private Equity Investment
 Investment by NRIs, VCs & HNIs
 Merger, de-merger, acquisition, consolidation, split, sale of business or dissolution of the
company
 The sale, lease or exchange of all or substantially all of the assets or undertaking of the
Company.

47. VALUATION ASPECTS
For ESOPs, there are basically 2 types of Valuations:
 Accounting Valuation: This Valuation is required for calculating Employee Compensation Cost during the
vesting period.
 Accounting valuation can be performed by any valuer
 Perquisite Valuation: This Valuation would be conducted only in case of unlisted Companies, at the time
of Exercise of Options by the Employee to know the value of the perquisite in employee’s hands.
 Perquisite valuation is performed by Merchant Banker

48. CHALLENGES FOR ESOPs – Budget 2017-18
 Finance Ministry has withdrawn the exemption from Long-term Capital Gain tax arising on
transfer of listed shares in case Securities Transaction Tax has not been paid at the time of
acquisition of shares.
 ESOP in a fresh allotment (excluding the secondary market acquisitions ) where payment of STT
at the time of acquisition of shares cannot be paid by the employees.
 This will lead to hardships on employee as he has to pay LTCG on transfer of shares which was
earlier exempt under Section 10(38) of Income Tax Act, 1961.

49. ESOPs FOR START-UPs
 Startups are cash-short, therefore ESOP is the best way to compensate employees
 Employees will get aligned to the interest of company
 To motivate ESOPs in Startups, Government has even allowed to offer ESOPs to Promoters & Directors
holding more than 10% of the outstanding equity share capital of the company – which is otherwise not
allowed.
 ESOPs can also prove to be a great tool at times of economic slow down where companies are low at
cash, however at the same time motivating employees is important. They can do so by offering them
equity.
HELPFUL TOOL IN CASH-CRUNCH

50. ESOPs IN PUBLIC SECTOR
 ESOPs, also welcomed by Public Sector
 Department of Public Enterprises Guidelines provide that ‘10%-25% of performance
related pays should be paid in the form of ESOPs.’
First implemented by NALCO
 Even the Finance Ministry has given its nod to ESOPs in Public Sector Banks.
 Final implementation stuck on decision of Bank Board Bureau.

51. SWEAT EQUITY- Another way to reward
Star Performers
 Eligibility:
- Promoter Directors
- Other Directors
- Permanent Employees
 Rewarded for:
- Value Addition
- IPR
- Technical know-how
 Pricing:
- Free of Cost
- Cash consideration
- Non-cash consideration
- Valuation to be done by
Registered Valuer
 Lock-in:
- 3 years from date of
allotment

52. CHECK POINTS FOR SWEAT EQUITY
 Special resolution valid for 12 months
 Annual Limit: 15% of existing paid-up equity share capital in a year or shares
of issue value of Rs. 5cr, whichever is higher
 At least one year must have elapsed since the date
on which the Company had commenced business.
 Overall Limit: 25% of the paid-up equity capital
 Accounting Treatment:
- Becomes MR : If Charged to P&L Account directly
- Not become MR : If consideration takes form of amortizable asset