We covered the different types of equity-based compensation structures in the last blog of our ESOP 101 series - What is Equity Compensation? However, before you can kick any scheme off the ground and implement it within your organization, it is vital to understand the underlying regulations and eligibility frameworks.
The Companies Act of 2013 and the Companies (Share Capital and Debentures) Rules of 2014 lays down the legal requirements and mandates for issuing equity to employees working in private companies. In addition, listed companies should follow the Securities and Exchange Board of India (SEBI) Employee Stock Option Scheme Guidelines.
💡It is essential to note that other than in the cases of employee stock option plan (ESOP) and sweat equity, the Indian company law does not recognize stock-related compensation methods such as stock appreciation rights (SAR) and restricted stock units.
Who is eligible?
According to Rule 12(1) of the 2014 Companies (Share Capital and Debentures) Rules, the following employees are eligible to receive an ESOP:
A permanent employee of the company who is working in India or outside India
A Director of the company, including a whole-time or part-time director but not an independent director
A permanent employee or director of a subsidiary company in India or outside India, or holding company, or an associate company
However, a company cannot issue ESOP to the following employees:
An employee who belongs to the promoter group or is a promoter of the company
A director who either himself or through any body corporate or his relative holds more than 10% of the outstanding equity shares of the company, whether directly or indirectly
However, the above two conditions do not apply to Startups registered under the “Startup India Initiative” for ten years from its incorporation.
As per provision to sub-section (1) of section 79A of the Companies Act, 1956 (1 of 1956) read with sub-section (1) of section 642 of the Companies Act, the following employees are eligible for sweat equity:
a permanent employee of the company working in India or out of India; or
a director of the company, employed as a whole-time director or executive director of a company;
an employee or a director as defined above of a subsidiary, in India or outside India, or of a holding company of the company;
A company has to disclose the following in the explanatory statement annexed to the notice for the passing of the special resolution to grant ESOPs:
The total number of stock options to be granted
The identified class of employees who can participate in the ESOP
Requirements of vesting period of ESOP
Maximum period within which the options can vest
The exercise price and process of exercise
The lock-in period, if any
The exercise period and process of exercise
The maximum number of options to be granted per employee and in aggregate
The methods used by the company to value its options
The conditions under which option vested in employees may lapse, for example, in case of termination of employment for misconduct
The specified time within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of an employee
A statement that the company will comply with the applicable accounting standards
At the time of the general meeting called for the issuance of sweat equity, the company has to disclose the following:
The total number of shares to be issued as sweat equity
The class or classes of directors or employees to whom such equity shares are to be issued
The principal terms and conditions on which sweat equity shares are to be issued, including the basis of valuation
The time of association of such a person with the company;
The names of the directors or employees to whom the sweat equity shares will be issued and their relationship with the promoter or/and Key Managerial Personnel
The price at which the sweat equity shares are proposed to be issued
The consideration, including consideration other than cash, if any, to be received for the sweat equity
The ceiling on managerial remuneration, if any, be breached by the issuance of such sweat equity and how it is proposed to be dealt with
A statement to the effect that the company shall conform to the applicable accounting standards
Diluted earnings per share, pursuant to the issue of sweat equity shares, shall be calculated in accordance with the applicable accounting standards.
💡A startup, as defined by the Department for Promotion of Industry and Internal Trade (DPIIT), may issue sweat equity shares not exceeding 50% of its paid-up capital up to five years from its incorporation or registration date.
What about SAR?
Stock Appreciation Right (SAR) has been gaining popularity in India as an equity compensation offering.
Under regulation 2 (1)(qq) of the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SEBI Benefits Regulations”), SARs have been defined as “a right given to a SAR grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company”.
Issuing SARs by an unlisted company remains unregulated and unrecognized under the SEBI Benefits Regulations or the Companies Act. However, there has been some progress. The Ministry of Corporate Affairs (MCA), under the report of the Company Law Committee published in March 2022, recommended that:
“The Committee was of the opinion that RSUs and SARs should be recognized under CA-13 through enabling provisions. If these schemes require the issue of further securities by the company, their issuance must be allowed only after approval of the shareholders through a special resolution. … However, where the settlement of such rights does not involve offer or conversion into securities, approval by shareholders need not be mandated.”
Even though unlisted Indian companies can issue SARs, it has been suggested to follow SEBI rules as good practice.
Stay tuned for the next blog!