Learn about SEBI regulations for employee stock option schemes for listed companies in India. We discuss compliance, disclosure requirements, and guidelines for trusts.
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In India, issuing employee stock option schemes for listed companies is not as simple as offering a few stock options.
The Securities and Exchange Board of India (SEBI) governs the process, ensuring companies comply with stringent regulations designed to protect both shareholders and employees.
An Employee Stock Option Plan (ESOP) or Employee Stock Option Scheme (ESOS) is a structured program through which companies incentivize their employees.
It grants them the right to purchase a specified number of company shares at a predetermined price, typically lower than the market value.
This is how it works:
The company identifies eligible employees and offers them stock options under the employee stock option scheme. These options are not shares yet but represent the right to acquire shares in the future, subject to certain conditions like performance or tenure.
Over a defined period, employees earn the right to exercise their stock options. This vesting period, often spanning 4 years, may be structured in stages, such as 25% vesting each year.
Once vested, employees can "exercise" their options by purchasing the shares at the pre-agreed price, known as the exercise price.
After acquiring the shares, employees can sell them on the stock exchange, usually after completing a lock-in period (if applicable).
Setting up an Employee Stock Option Plan (ESOP) for a listed company in India requires careful planning and compliance with legal frameworks.
The first step is to get approval for the ESOP at both the Board of Directors' meeting and shareholders' meeting.
A resolution must be passed, outlining the key aspects of the plan.
This may include the total number of shares available for allocation under the scheme, the eligibility criteria, and the vesting schedule.
After obtaining approval, the next step is to draft the ESOP policy or scheme. This document should define crucial terms such as:
- eligibility
- vesting period
- exercise period
It is important to ensure that the ESOP complies with the regulations outlined by SEBI, the Companies Act, 2013, and other applicable laws.
SEBI’s ‘Share-Based Employee Benefits And Sweat Equity Regulations’ outline specific guidelines for listed companies, such as transparent valuation methods, mandatory disclosures, and restrictions on granting options to independent directors.
Additionally, the Companies Act sets out approval and reporting requirements for issuing stock options.
Once the plan/scheme is approved, it's time to implement it.
This involves communicating the ESOP scheme to employees and issuing grant letters.
The Securities and Exchange Board of India (SEBI) regulates the issuance and management of Employee Stock Option Plans (ESOPs) for listed companies in India.
SEBI's ‘Share-Based Employee Benefits And Swear Equity’ regulations, 2021 defines the compliance framework, covering:
SEBI defines who can participate in ESOPs:
Notably, independent directors, promoters and employees belonging to the promoter group are excluded from receiving ESOPs.
The exercise price, which is the price at which employees can purchase shares, must be determined by a formula or parameters approved by shareholders during the ESOP resolution.
This price is usually set below the market price to make the ESOPs attractive, but it must:
SEBI mandates a minimum vesting period of one year.
Companies have the flexibility to set longer vesting periods or structure vesting based on individual or company milestones.
Special provisions:
As per the Companies Act, 2013, the board’s report must include:
This ensures comprehensive reporting of the ESOP scheme’s implementation and impact.
SEBI mandates companies to provide ESOP-related information in their financial statements, including:
These disclosures help investors assess the financial implications of the ESOP scheme.
Listed companies must file periodic disclosures with the stock exchanges, including:
This ensures ongoing transparency and compliance with SEBI guidelines.
When seeking shareholder approval for an ESOP scheme or its amendments, companies must disclose:
These details enable shareholders to make informed decisions about the ESOP plan’s adoption or modification.
The company’s annual report must include:
To meet SEBI and other regulatory requirements, companies must disclose:
SEBI imposes certain restrictions on the issuance of ESOPs:
Companies can administer ESOPs directly or through an ESOP trust.
If a trust is used:
The trust cannot be used for trading shares in the secondary market, except in specific cases, such as:
SEBI guidelines provide a clear framework on the eligibility criteria for ESOP issuance:
1. Permanent employees of the company or its subsidiaries
ESOPs can be granted to permanent employees of the parent company and its subsidiaries whether in India or abroad.
2. Directors (excluding independent directors)
Both full-time and part-time directors are eligible for ESOPs, provided they:
3. Consultants or advisors (if approved by shareholders)
Certain identified personnel, such as consultants, advisors, or contractors, may also be eligible for ESOPs under specific conditions:
A company cannot issue ESOPs to:
Note: These conditions don't apply to startups under the "Startup India Initiative" for 10 years from incorporation.
A startup is a company with an annual turnover under ₹100 crore with a focus on innovation, intellectual property, and the development of new products with significant potential for creating jobs.
Yes, Employee Stock Option Plans (ESOPs) are allowed under the Companies Act, 2013, as outlined in Section 62(1)(b).
This provision permits companies to issue shares to employees through ESOP, subject to specific conditions and regulatory requirements.
Before implementing an ESOP, companies must obtain approval from their shareholders through a special resolution passed in a general meeting. The resolution ensures that stakeholders are informed about and agree to the potential equity dilution resulting from the ESOP.
For listed companies, the SEBI (Share-Based Employee Benefits) Regulations, 2014 take precedence, supplementing the Companies Act’s provisions. These guidelines ensure that listed entities adhere to additional standards, such as stock exchange disclosures, fair pricing practices, and investor protections.
No, ESOPs are not limited to listed companies.
Unlisted companies can also offer ESOPs to their employees.
However, ESOPs differ between listed and unlisted companies in terms of liquidity, valuation, and regulatory compliance.
Here’s a detailed comparison:
Listed companies: Employees in listed companies enjoy immediate liquidity, as they can sell their shares on stock exchanges once the options are exercised. This ease of exit makes ESOPs highly attractive in these companies.
Unlisted companies: Liquidity is more complex. Employees rely on buyback programs or secondary sales to cash out, which may not be readily available and often depend on the company’s growth stage or funding cycles.
Listed companies: Shares have a transparent market value, determined by real-time trading on stock exchanges. Employees and the company have a clear understanding of the ESOP's monetary worth.
Unlisted companies: Share valuation depends on external valuations conducted by experts, often during funding rounds. The lack of daily price discovery makes the value less predictable and harder to benchmark.
In India, employee stock option schemes (ESOS) for both listed and unlisted companies are regulated by the Companies Act, 2013. This Act establishes a broad framework of rules that complement other specific regulations.
Listed companies: For listed companies, the SEBI (Share Based Employee Benefit & Sweat Equity) Regulations, 2021, apply.
Unlisted companies: On the other hand, unlisted companies are governed by the Companies (Share Capital and Debentures) Rules, 2014, instead of the SEBI regulations.
Listed companies: Employees face taxation at the time of exercise (as a perquisite under salary) and sale (capital gains).
Unlisted companies: They also have similar tax implications for employees as listed companies.
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