LexStart makes MANAGING
your ESOP pool a breeze

Why LexStart ?

Handholding through ESOP implementation process

Our team of experts will guide you through the entire process, from creating to managing your ESOP options

Unique online portal to manage ESOP options & increase transparency

Create and manage ESOP options easily, using our online portal. Increase transparency by giving your employees access to status of their option, using separate logins

100+ Startups benefitted through LexStart services

We guide you through the maze of legal compliances, but also take care of them, without burning a hole in your pocket. Simply put, we act as your start up's in-house counsel and compliance manager

STRUCTURING

Provide options forstructuring incentive plans, Pros and Cons ofeach, give insight on industry practice and design your preferred incentive plan

CREATING

Once you know what you want, we will draft all the requisite documentation, including the plan, grant letters, exercise notice corporate resolutions, et al

IMPLEMENTING

Handhold you through the process of getting the requisite corporate approvals and make all statutory filings that would be required

MANAGING

Assist with granting incentives. Intimating employees upon vesting. Assisting with all corporate formalities upon exercise of plan or cessation of employment

Why ESOPs ?

Attract and retain talent

In its early stages, a company is usually bootstrapping and may not have the resources to pay attractive compensation packages to employees. However, they can use employee incentive plans to attract and retain good employees as there is no cash outlay involved in the company in such cases.

Incentivize employees by allowing them to participate in growth of Company

In its early stages, a company is usually bootstrapping and may not have the resources to pay attractive compensation packages to employees. However, they can use employee incentive plans to attract and retain good employees as there is no cash outlay involved in the company in such cases.

Give a sense of ownership to employees

In its early stages, a company is usually bootstrapping and may not have the resources to pay attractive compensation packages to employees. However, they can use employee incentive plans to attract and retain good employees as there is no cash outlay involved in the company in such cases.

Who can you give ESOPs to ?

Permanent employee of the company,

who has been working in India or outside India

Director of the company,

as long as such director is not (a) an independent director, or (b) holding more than 10% of the company, directly or indirectly

An employee of a subsidiary,

in India or outside India, or of a holding company.

Promoters of a company,

where the company has a Startup Recognition Certificate

LexStart ESOP Package


The package has been designed to handhold a start up from the point it starts thinking about an incentive plan to designing, creating, implementing and managing it on our unique web based platform. Our automated process will keep you and your employees informed about the status of options.

The complete package consists of the following two components:

ESOP INITIATION

Structuring the ESOP offering

Drafting the Employee Stock Option Policy

All corporate resolutions

Statutory filings under Companies Act 2013

₹ 25,000/- (exclusive of GST)

ESOP MANAGEMENT

Dynamic dashboard

Assisting with granting of options

Intimation of vesting to employees

Assisting with exercise of options

Assisting with appropriate steps upon cessation of employment

All resolutions and statutory filings under the Companies Act

₹ 18,000/- p.a (for upto 10 employees) (exclusive of GST)

How does it work ?

Our automated process will keep the startup and its employees informed about the status of options.

Understand how ESOPs work

1 hr

Create the ESOP Policy

1 hr

Get Board members & Shareholder approval

5 min

Create the ESOP Policy

1 min

Our online portal helps you manage your company’s ESOPs, covering a wide range of functional requirements. The ESOP module consists of the following sections:

1. ESOP Form - Draft Policies

1. Create a new Draft policy and fill the form, once the form has been submitted, the draft can be exported into a word document which goes into the hands of a lawyer for futher review.

2. The ESOP form captures most of the information required to draft a new policy. The form is divided into sections for easier understanding.

3. LexGyaan, i.e. the right section of the page containing the form, explains different aspects of the ESOP policy in a suggestive manner, so that the user can make informed decisions.

4. Once the form has been filled, pass it on to LexStart, just click on the submit button. LexStart will create a draft, review and help you execute the policy.

Are you interested in availing this ESOP module?

BOOK A FREE CONSULTATION

LexStart Blog


August 18, 2015

By Karthik Chandrasekar

The role of ESOP in Start ups

In a roller coaster ride of a start up, employee retention through thick and thin is extremely critical - especially in today's market where the focus is on growing fast.

Read More

June 7, 2016

By Anisha Patnaik

Did you know that there is a mandatory 1 year cliff on ESOPs?

A cliff is the time period between grant of ESOPs to an employee and vesting of the ESOPs. Under the Indian Companies Act, 2013, there has to be...

Read More

August 18, 2015

By Karthik Chandrasekar

The role of ESOP in Start ups

In a roller coaster ride of a start up, employee retention through thick and thin is extremely critical - especially in today's market where the focus is on growing fast.

Read More

Frequently Asked Questions

Q: Are employee incentive plans mandatory under the Indian laws?

Employee Stock Incentive Plan in this case refers to ESOPs, ESPPs, RSUs, RSAs, SARs and any other innovative employee incentive plan that a company/ startup may come up with. It is not mandatory under Indian laws to grant stock incentives including ESOPs, to employees in a private limited company/ startup.

Having said that, if a private limited company/ startup decides to grant ESOPs to its employees, it will have to follow the provisions of the Companies Act, 2013.

Most Popular Stock Incentive Plan ESOPs are the most common form of employee incentive plans in India. The same could also be because of the universal acceptance of the concept of stock options/ ESOPs thus giving clarity to how ESOPs work and taxation of the same.

Also from the employee's perspective, there is more familiarity with stock options/ ESOPs than any other stock incentive plan. Should you implement a Stock Incentive Plan? Although, it is not mandatory under the Indian laws to implement a stock incentive plan, most startups implement a stock option/ ESOP plan. The reason being that, when starting up, attracting and retaining talent is one of the biggest challenges for any startup. In such situations it becomes imperative for a startup to structure and implement a stock incentive/ ESOP plan. Granting stock options/ESOPs to employees gives them an opportunity to have a share in the company, the startup that they are working so hard to build acts as a great motivator.

Where ESOPs are a great tool to motivate employees, if not implemented on time, they can actually become a cause of disconcert amongst the employees. Imagine a situation where you brought on an employee with the promise of ESOPs and two years down the line, he still hasn't seen or received any ESOPs. It is therefore important to implement ESOPs as soon as possible.

Q: Why should a company have employee incentive plans?

Most startups face the challenge of attracting talent due to their limitations to pay market-level salaries. ESOPs serve as a good way of supplementing compensation in order to attract talent. ESOPs also allow employees to participate in the growth story of the company/startup, thus incentivizing them further. The benefits of ESOPs or employee incentives are plenty. But the most important benefits are as follows:

(a) Attracting and retaining talent: ESOPs are useful to startups in attracting talent. In its early stages, a company is usually bootstrapping and may not have the resources to pay attractive compensation packages to employees. However, they can use ESOPs or other employee incentive plans to attract and retain good employees as there is no cash outlay involved in the company in such cases.

(b) Sense of ownership for the employees: When employees are given ESOPs which eventually convert in to shares of a company in which they are working, it gives them a sense of ownership, thus incentivizing them further.

Where ESOPs are a great tool to motivate employees, if not implemented on time, they can actually become a cause of disconcert amongst the employees. Imagine a situation where you brought on an employee with the promise of ESOPs and two years down the line, he still hasn't seen or received any ESOPs. It is therefore important to implement ESOPs as soon as possible.

Most Popular Stock Incentive Plan

ESOPs are the most common form of employee incentive plans in India. The same could also be because of the universal acceptance of the concept of stock options/ ESOPs thus giving clarity to how ESOPs work and taxation of the same. Also from the employee's perspective, there is more familiarity with stock options/ ESOPs than any other stock incentive plan.

Q: What are the different types of employee incentive plans?

The different types of employee incentive plans are as follows: Employee Stock Option Plan (ESOPs) Employee Stock Purchase Plan (ESPP) Stock Appreciation Right/Phantom Equity Plan Restricted Stock Award Restricted Stock Unit Any Other?

Please do write to us if you have come across any other innovative incentive plan that you would like to use to attract talent and incentivize employees

ESOPs: Employee Stock Option Plan or ESOPs are options granted to an employee to buy shares of the company (also referred to as exercise of ESOPs) at a predetermined price (also referred to as exercise price of ESOPs), subject to certain conditions, such as active employment with the company over a vesting period and meeting individual or team level performance based milestones.

ESPP: An Employee Stock Purchase Plan allows an employee to acquire shares of the company on a future date, at a price lower than the prevailing market price. In case of an Employee Stock Purchase Plan, the employer deducts a certain amount from the employee's salary on a regular basis, and after a certain period of time, the employee is granted shares in the company in consideration for the amount retained from their salary.

Stock Appreciation Right Plan or Phantom Equity Plan: A Stock Appreciation Right Plan or Phantom Equity Plan refers to notional shares allotted to employees. Both Stock Appreciation Right Plan or Phantom Equity Plan are very similar and are essentially cash bonus plans, although some plans pay out the benefits in the form of shares.

Restricted Stock Unit: Under a Restricted Stock Unit Plan or an RSU, the employee is entitled to receive stock at some specified date in the future, subject to certain conditions at a fair market value assigned to the Restricted Stock Unit at the time of vesting. The difference between ESOP and a Restricted Stock Unit is that while in case of an ESOP, the employee has an option to purchase shares of the company, in case of a RSU or a Restricted Stock Unit, the employee is allotted shares upon the occurrence of a vesting event.

Restricted Stock Award: Under a Restricted Stock Award plan or RSA, the employee receives the shares upfront when the Restricted Stock Award is granted.

Q: What is an Employee Stock Option Plan?

Employee Stock Option Plan or ESOPs are options granted to an employee to buy shares of the company (also referred to as exercise of ESOPs) at a predetermined price (also referred to as exercise price of ESOPs), subject to certain conditions, such as active employment with the company over a vesting period and meeting individual or team level performance based milestones.

The Exercise Price of ESOPs, i.e., price at which the employee can buy shares is fixed at the time of granting the ESOPs. Usually, this price is par value of the shares or market value of the shares at the time of grant. As a result, the employee gets the benefits of buying shares of the company at a discount to the market price of the shares of the company (assuming the company has done well).

An employee who has been granted ESOPs can exercise his right to acquire shares, upon the ESOPs vesting on him. This right of an employee to buy the shares is not in perpetuity and is usually subject to certain restrictions, including an Exercise Period and sometimes a lock-in-period.

Illustration: ABC Pvt. Ltd. offers ESOPs to Mr. X, under the terms of which Mr. X is entitled to 200 equity shares of ABC, amounting to 2% of the paid-up share capital of ABC at the time of grant of the ESOPs, at par value of the shares. The ESOPs granted to Mr. X are exercisable as per the schedule set out below:

25% of the ESOPs shall be exercisable upon completion of 2 years by Mr. X with ABC 25% of the ESOPs shall be exercisable upon completion of 3 years by Mr. X with ABC 25% of the ESOPs shall be exercisable upon completion of 4 years by Mr. X with ABC 25% of the ESOPs shall be exercisable upon completion of 5 years by Mr. X with ABC

This means that once Mr. X has completed 2 years with ABC, he will be entitled to buy 50 equity shares of ABC at Rs.10/share. Please understand that it is not mandatory for Mr. X to buy these shares once he is entitled to them. It is his option to buy the shares if he wants to. The policy will state the time period till when Mr. X can exercise this option. Such period is referred to as the Exercise Period. However, if not exercised, the option to buy the shares will lapse after the Exercise Period.

Q: How is an ESPP different from ESOP?

ESOP is an option given to an employee to buy shares of the company at a later date. Since ESOP is an option, an employee does not have to mandatorily buy shares of the company. On the other hand, a ESPP is a purchase plan implemented by a company, where the company withholds certain part of the employee's salary to ESPP every month for a predetermined term. Upon completion of the term, the ESPP holding employee is issued shares of the company. Unlike an ESOP, in case of ESPP the employee doesn't have an option to buy shares. He has to mandatorily buy shares of the company.

Illustration: ABC Pvt. Ltd. offers an ESPP to Mr. X, under the terms of which Mr. X can contribute 5% of his salary every month for a year, at the end of which he can buy shares of ABC at a 10% discount to the price of the shares on the date of grant of the ESPP, using the money contributed from his salary. Therefore, if the price on the date of issue of ESPP is Rs. 100, Mr. X can exercise the right to buy the shares a year later at Rs. 90/share, i.e., 10% discount to Rs.100.

Q: What is a Stock Appreciation Right / Phantom Equity Plan?

Under a Stock Appreciation Right Plan or Phantom Equity Plan, employees of companies/startup are given the right to the appreciating value of certain no. Of shares in such Company/Startup. In other words, they are granted notional shares and not actual shares in the company/startup. Both Stock Appreciation Right Plan or Phantom Equity Plan are very similar plans and are essentially cash bonus plans.

Stock Appreciation Right Plan/Phantom Equity Plan typically provide the employee with a cash payment based on the increase in the value of the employee's shares over a specified period of time. In case of both Stock Appreciation Right Plan or Phantom Equity Plan, employees typically never become shareholders of the company.

How do Stock Appreciation Right Plan/Phantom Equity Plan work? The following illustration should clarify your doubts: ABC Pvt. Ltd. issues 1000 phantom shares to Mr. X to be vested upon completion of 2 years in the company, at the value of the shares on the exercise date. At the end of completion of 2 years, if the fair market value of the equity shares of ABC is Rs.100, then Mr. X will be paid Rs.100,000 after deducting TDS at applicable tax rate.

Stock Appreciation Right Plan/Phantom Equity Plan Vs. Other Stock Incentive Plans. The most important difference between a Stock Appreciation Right or a Phantom Equity and all other forms of employee incentive plans is that while in all other cases, the employee of a company/startup, at some point owns shares in such company/startup and hence becomes a shareholder in such company/startup. In the case of Stock Appreciation or Phantom Equity, as the name suggests there are no shares, they are just "phantom" or nonexistent shares.

Benefits of Stock Appreciation Right Plan/Phantom Equity Plan for the Company/Startup/Employer. The Stock Appreciation Right Plan or Phantom Equity Plan allow the employee to partake in the benefits of increasing value of the company without having to go through the process of allotment of shares of bringing the employees on the cap table. Therefore, from a company/startup/employer perspective, it is a great structure as it has minimum paper work and the company/startup doesn't have to go through the paperwork of allotting shares each time an employee exercises stock incentives, like in the case of ESOPs, ESPPs, RSUs and RSAs.

Benefits of Stock Appreciation Right Plan/Phantom Equity Plan for the Employee From the employee's perspective, Stock Appreciation Right/Phantom Equity Plan allows the employee to enjoy the benefits of increasing value of the shares, without worrying about the various tax implications that arise in case of other stock incentive plans, especially ESOPs. Moreover, in case of all other stock incentive plans including ESOPs, the employee gets to enjoy the benefits of being a shareholder only when he is able to sell his shares. However, in case of Stock Appreciation Right Plan/Phantom Equity Plan, the employee doesn't have to worry about liquidity for his shares.

Q:What is a Restricted Stock Unit?

Under a Restricted Stock Unit Plan or a RSU, the employee is entitled to receive shares of the company/startup at a specified date in the future, subject to certain conditions. The shares are typically issued at the fair market value of the company/startup, at the time of vesting of such right.

How do RSUs work?

The following illustration may help understand how RSUs typically work: ABC Pvt. Ltd. offers 999 RSUs to Mr. X vested equally over 3 years. This means that Mr. X will get 333 equity shares of ABC upon completion of Year 1, 2 and 3, respectively. Unlike in the case of an ESOP, Mr. X will not be required to pay for the shares. Effectively, the shares will be issued to Mr. X for free.

RSU Vs. ESOP and Other Employee Incentive Plans The difference between ESOP and a Restricted Stock Unit is that while in case of a ESOP, the employee has an option to purchase shares of the company/startup, in case of an RSU or a Restricted Stock Unit, the employee is allotted shares upon the occurrence of the vesting event, and doesn't have to typically buy these shares. However, given the Indian Companies Act requirement, this structure becomes difficult to implement, as the Act doesn't provide for allotment of shares for "free" and the terms for issuance of sweat equity are quite a few.

But unlike an RSA, the employee does not actually receive shares, unless the conditions are met and so does not have voting rights or rights to receive dividends on the date of grant. The employee receives the shares only once the conditions are met.

Q: What is a Restricted Stock Award?

Under a Restricted Stock Award plan or RSA, the employee receives shares of the company/startup upfront when the Restricted Stock Award is granted. The Restricted Stock Award plan is the most generous of all employee incentive plans that are typically in practice.

Restricted Stock Award Vs. Other Employee Incentive Plans

This is because, unlike all other incentive plans, including ESOPs, where the employee has the right to buy or enjoy the benefits of shares only after vesting has occurred, in the case of a Restricted Stock Award or RSA, the employee gets the shares upfront subject to certain conditions. If the conditions are not met, then the shares are forfeited. Unlike an ESOP, in case of Restricted Stock Award/RSA, the employee is considered to be the owner of the shares from the date of the Restricted Stock Award is granted and is entitled to receive dividends and has voting rights immediately. Additionally, once shares are allotted, if the employee does not meet the conditions, then enforcing a buy back of shares from the employee may be challenging. Which is why incentive structures such as ESOPs are more popular, as the employee has to earn the right to buy shares in the company as opposed to getting the shares upfront and putting the onus on the company to retrieve them in case of default, as is the case with Restricted Stock Awards.

Restricted Stock Award for Startups

For reasons stated in the preceding paragraph, a Restricted Stock Award/RSA is not very popular in early stage companies/startups in India or in fact even with private limited companies.

Q: Which is the most popular mode of granting stock incentives to employees in India?

ESOPs are the most popular mode of employee stock incentives. This is because ESOPs as employee stock incentive structure have been used more widely and commonly. As a result there is clarity in the way ESOPs function both for employer and employee. Even from familiarity perspective, employees and employers are more familiar with ESOPs than other mode of employee incentives.

Employee Stock Option Plan or ESOPs are options granted to an employee to buy shares of the company (also referred to as exercise of ESOPs) at a predetermined price (also referred to as exercise price of ESOPs), subject to certain conditions, such as active employment with the company over a vesting period and meeting individual or team level performance based milestones.

Illustration: ABC Pvt. Ltd. ("ABC") offers ESOPs to Mr. X, under the terms of which Mr. X is entitled to 200 equity shares of ABC, amounting to 2% of the paid-up share capital of ABC at the time of grant of the ESOPs, at par value of the shares. The ESOPs granted to Mr. X are exercisable as per the schedule set out below:

25% of the ESOPs shall be exercisable upon completion of 2 years by Mr. X with ABC
25% of the ESOPs shall be exercisable upon completion of 3 years by Mr. X with ABC
25% of the ESOPs shall be exercisable upon completion of 4 years by Mr. X with ABC
25% of the ESOPs shall be exercisable upon completion of 5 years by Mr. X with ABC

This means that once Mr. X has completed 2 years with ABC, he will be entitled to buy 50 equity shares of ABC at Rs. 10/share. Please understand that it is not mandatory for Mr. X to buy these shares once he is entitled to them. It is his option to buy the shares if he wants to. The policy will state the time period till when Mr. X can exercise this option. Such period is referred to as the "Exercise Period". However, if not exercised, the option to buy the shares will lapse after the Exercise Period.

Q: WWho is eligible to receive ESOPs?

ESOPs are governed under the Companies Act, 2013. Under the Companies Act, 2013, ESOPs can only be granted to employees or some directors. Please see below for the detailed list of persons to whom ESOPs can be granted:

(a) a permanent employee of the company/startup, whether working in India or outside India
(b) director of the company/startup, as long as he not an independent director
(c) director of the company/startup, as long as he holds less than 10% of the paid up share capital of the company, whether directly or through his relative or through any body corporate, directly or indirectly
(d) an employee of a subsidiary, in India or outside India
(e) an employee of a holding company.
(f) Promoters of a company if such company has received a "Startup" recognition from DIPP,

Government of India and such grant is proposed to be made within 5 years from teh date of incorporation of the Startup.

Who cannot be granted ESOPs?

(a) Part time employee
(b) Advisor
(c) Mentor
(d) Consultant
(e) Promoter/Co-founder of a company not recognized as a Startup by the DIPP, Government of India, or in case of a recognized Startup, where such grant is proposed to be made after 5 years from the date of incorporation.

Private limited companies especially company in early stages of business or startups typically like to grant ESOPs to part time employees, advisors, mentors, consultants and co-founders. However, considering the provisions of the Companies Act, 2013, these persons cannot be granted ESOPs unless they are permanent employees of the company or are directors holding less than 10% of the share capital of the company/startup. For such persons, the company will have to structure different modes of stock incentive plans and not the statutorily regulated ESOPs. Warrants or partly paid up shares are popular instruments for incentivizing advisors and mentors.

Q: Who is eligible to receive ESOPs?

ESOPs are governed under the Companies Act, 2013. Under the Companies Act, 2013, ESOPs can only be granted to employees or some directors. Please see below for the detailed list of persons to whom ESOPs can be granted:

(a) a permanent employee of the company/startup, whether working in India or outside India
(b) director of the company/startup, as long as he not an independent director
(c) director of the company/startup, as long as he holds less than 10% of the paid up share capital of the company, whether directly or through his relative or through any body corporate, directly or indirectly
(d) an employee of a subsidiary, in India or outside India
(e) an employee of a holding company.
(f) Promoters of a company if such company has received a “Startup” recognition from DIPP,

Government of India and such grant is proposed to be made within 5 years from teh date of incorporation of the Startup.

Who cannot be granted ESOPs?

(a) Part time employee
(b) Advisor
(c) Mentor
(d) Consultant
(e) Promoter/Co-founder of a company not recognized as a Startup by the DIPP, Government of India, or in case of a recognized Startup, where such grant is proposed to be made after 5 years from the date of incorporation.

Private limited companies especially company in early stages of business or startups typically like to grant ESOPs to part time employees, advisors, mentors, consultants and co-founders. However, considering the provisions of the Companies Act, 2013, these persons cannot be granted ESOPs unless they are permanent employees of the company or are directors holding less than 10% of the share capital of the company/startup. For such persons, the company will have to structure different modes of stock incentive plans and not the statutorily regulated ESOPs. Warrants or partly paid up shares are popular instruments for incentivizing advisors and mentors.

Q: Who is an independent director?

An independent director is defined under the Companies Act, 2013, as a director other than a managing/whole-time/nominee director, who:

(a) is or was not a promoter, or related to promoters or directors of the company;
(b) has or had no pecuniary relationship with the company, or its promoters or its directors, during the current or 2 preceding financial years;
(c) has no relative, who has or had pecuniary relationship with the company, or its promoters or its directors, amounting to 2% or more of its gross turnover or Rs.5,000,000/-, whichever is lower, during the current or 2 preceding financial years;

(d) neither himself nor his relative:
(i) is or has been a key managerial personnel of the company in the 3 preceding financial years;
(ii) is or has been an employee or a proprietor or a partner, in the 3 preceding financial years, of a firm of auditors or company secretaries in practice or cost auditors of the company; or any legal or a consulting firm that has or had any transaction with the company amounting to 10% or more of the gross turnover of such firm;
(iii) holds with his relatives 2% or more of the total voting power of the company; or
(iv) is a chief executive or director, of any nonprofit that receives 25% or more of its receipts from the company, or its promoters or its directors or that holds 2% or more of the total voting power of the company.

It is not mandatory for a private limited company to appoint an independent director on its Board of Directors.

Q: Is a promoter entitled to ESOPs?

Promoter of a company, irrespective of whether he is an employee of the company, or not, is not eligible for ESOPs under the Companies Act, 2013. However, if such company is recognized as a “Startup” by DIPP, Government of India, the the promoter of such a Startup can be granted ESOPs, as long as such grant is made within 5 years from the date of incorporation of such startup.

Who can be granted ESOPs?

(a) a permanent employee of the company/startup, whether working in India or outside India
(b) director of the company/startup, as long as he not an independent director
(c) director of the company/startup, as long as he holds less than 10% of the paid up share capital of the company, whether directly or through his relative or through any body corporate, directly or indirectly
(d) an employee of a subsidiary, in India or outside India
(e) an employee of a holding company.
(f) Promoters of a company if such company has received a “Startup” recognition from DIPP, Government of India as long as such grant is made within 5 years from the date of incorporation of such startup.

Who cannot be granted ESOPs?

(a) Part time employee
(b) Advisor
(c) Mentor
(d) Consultant
(e) Promoter/Co-founder of a company not recognized as a Startup by the DIPP, Government of India or where recognized, where such grant is proposed to be made 5 years after the date of incorporation of such startup.

Who is a Promoter?

The term “Promoter” has been defined under the Companies Act, 2013. A Promoter with respect to a Startup or a Company refers to persons in the following capacity:

(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. However, if such person is acting merely in a professional capacity, then such person shall not be considered a Promoter.

Alternate Stock Incentive Plans

Private limited companies especially company in early stages of business or startups typically like to grant ESOPs to part time employees, advisors, mentors, consultants and co-founders. However, considering the provisions of the Companies Act, 2013, these persons cannot be granted ESOPs unless they are permanent employees of the company or are directors holding less than 10% of the share capital of the company.

Q: Is there a minimum percentage prescribed under the law for an ESOP pool?

No, there is no minimum percentage prescribed under the Indian laws for an ESOP pool. Typically ESOP pool vary between 8-15% pre any fundraise. The size of a ESOP pool can be determined after taking into consideration the following factors:

1. Purpose of the pool

It is important to first determine the reason/objective for setting up the esop pool. For example, if the pool is being set up to compensate for reduced compensation or is it being set up to incentivize employees, and issue esops more as a bonus. If the objective is the former, then the pool should be on higher side of the spectrum set out above. If it is the latter, then it should be on the lower side of the spectrum

2. No. of Co-founders

Where a company has multiple co-founders, the company would not ideally require to hire senior management level employees and thus, would require far lesser esops. In such a case the pool can be on the lower side of the spectrum. On the other hand, in case of a company with a solo founder, multiple management level hires will have to be made and hence larger esop stakes will have to be issued by the company. In such cases, the company will have to have a larger esop pool.

3. Nature of business

One needs to also take in to consideration the nature of business while determining the esop pool size. If your business is manpower heavy, then you will have larger no. of employees, hence more no. of ESOPs would be required. As a result, your ESOP pool should be bigger.

Q: Can an employee transfer the stock options?

No. ESOPs are not transferable. The rights, options or stocks granted to employees under an incentive plan or through ESOPs, cannot be transferred to any other person. ESOPs cannot be marketable, because (a) these are options granted to specific employees and hence are personal to such employee. Transferring the option would defeat the entire objective of granting the ESOPs, (b) ESOPs do not give any rights to the holder, including the dividend and voting right.

Additionally the ESOPs granted to employees under an ESOP policy cannot be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

Transferability of Shares upon Exercise of ESOPs

Once an employee exercises the ESOPs granted to him/her, the employee is issued shares in the company/start up and effectively becomes shareholder of the company. Upon becoming the shareholder, the employee may be restricted from freely transferring the shares in the company/start up. This would depend on the ESOP Policy and Charter Documents, more specifically Articles of Association of the company.

Typically the restrictions would be one or more of the following:

(a) Transfer of shares by an employee shall be subject to approval of the Board
(b) Transfer of shares by an employee shall be subject to the Right of First Refusal or Right of First Offer of the Promoter/Investor/Other Shareholders
(c) Employee cannot transfer shares to a competitor of the company/start up
(d) Employee cannot transfer shares below Fair Market Value of the company/start up

In the absence of any transfer restrictions in either the ESOP Policy of the Charter Documents of a company/start up, an employee will be free to transfer his/her shares in such company/start up.

Q: What does granting of an ESOP mean?

Granting of ESOPs is the process of offering the ESOP to an employee. An ESOP is said to be granted only when an employer issues/offers the ESOPs to the employee and the employee accepts it.

How does granting work?

The below illustration should be able to help:

ABC Pvt. Ltd. (“ABC”) issues a grant letter to Mr. X granting him ESOPs of 0.5%. The ESOPs will be granted to Mr. X upon acceptance of the offer by him. Grant date will, therefore, be the date stated in the grant letter.

Is an Offer Letter for Employment and Grant Letter the same?

Typically the offer letter for employment of an employee includes the promise of ESOPs as well. However, an employee offer letter is usually not the same as a ESOP grant letter. An employment offer letter will be construed as the grant letter if the following conditions are met:

(a) if the Board has allowed for an offer letter and ESOP grant letter to be the same, and
(b) the offer letter clearly sets out all the terms and conditions of the ESOPs being granted, and
(c) most importantly, the Company has an ESOP policy in place, then the offer letter and ESOP grant letter can be the same. Most startups develop their stock incentive plans a few months/year after starting their business or just when they are about to hire a few senior employees or when they are fundraising since it is a requirement from the investor.

One, therefore, has to be clear on the grant date, because you cannot grant ESOPs without having an ESOP Policy in place.

Q: Does the law prescribe any guidelines for grant of incentives?

Currently, the only statute that deals with grant of ESOPs for private limited companies/startups, in India is the Companies Act, 2013. Under the Companies Act, 2013 and the rules made thereunder, ESOPs can only be granted to the following persons:

(a) a permanent employee of the company/startup, whether working in India or outside India
(b) director of the company/startup, as long as he not an independent director
(c) director of the company/startup, as long as he holds less than 10% of the paid up share capital of the company, whether directly or through his relative or through any body corporate, directly or indirectly
(d) an employee of a subsidiary, in India or outside India
(e) an employee of a holding company.
(f) Promoters of a company if such company has received a “Startup” recognition from DIPP, Government of India as long as such grant is made within 5 years from the date of incorporation of such startup.

Who cannot be granted ESOPs?

(a) Part time employee
(b) Advisor
(c) Mentor
(d) Consultant
(e) Promoter/Co-founder of a company not recognized as a Startup by the DIPP, Government of India or where recognized, where such grant is proposed to be made 5 years after the date of incorporation of such startup.

Additionally, the law also imposes a 1 year cliff on the vesting of ESOPs. This means that an employee cannot enjoy the benefits of ESOPs or purchase shares against the ESOPs in the first year of grant, even if the employer/startp wants to allow the employee to do so.

Q: What are the prerequisites for granting ESOPs?

In order for a company/startup to be able to grant ESOPs to its employees, it has to first create an Employee Stock Option Policy and then obtain approval of its Board of Directors and shareholders on the same. Typically the offer letter for employment of an employee includes the promise of ESOPs as well. However, an employee offer letter is usually not the same as a ESOP grant letter.

An employment offer letter will be construed as the grant letter if the following conditions are met:

(a) if the Board has allowed for an offer letter and ESOP grant letter to be the same, and
(b) the offer letter clearly sets out all the terms and conditions of the ESOPs being granted, and
(c) most importantly, the Company has an ESOP policy in place, then the offer letter and ESOP grant letter can be the same. Most startups develop their stock incentive plans a few months/year after starting their business or just when they are about to hire a few senior employees or when they are fundraising since it is a requirement from the investor.

One, therefore, has to be clear on the grant date, because you cannot grant ESOPs without having an ESOP Policy in place.

What is a ESOP grant letter?

A ESOP grant letter is a letter issued to an employee setting out terms of the ESOPs granted to such employee. It is only when an ESOP grant letter is issued that a company is said to have granted ESOPs to such employee.

Q: Does an employee receive voting rights or dividend rights when ESOPs are granted to him?

No, an employee does not receive any voting or dividend rights with the grant of ESOPs, unless he exercises the ESOPs and buys shares in the company/startup. Once an employee buys shares in the company, he gets voting and dividend rights. One has to remember that ESOPs are not shares, ESOPs are options granted to an employee to buy shares of the company (also referred to as exercise of ESOPs) at a predetermined price (also referred to as exercise price of ESOPs), subject to certain conditions, such as active employment with the company over a vesting period and meeting individual or team level performance based milestones.

An employee who has been granted ESOPs can exercise his right to acquire shares, upon the ESOPs vesting on him. This right of an employee to buy the shares is not in perpetuity and is usually subject to certain restrictions, including an Exercise Period and sometimes a lock-in-period.

Illustration: ABC Pvt. Ltd. (“ABC”) offers ESOPs to Mr. X, under the terms of which Mr. X is entitled to 200 equity shares of ABC, amounting to 2% of the paid-up share capital of ABC at the time of grant of the ESOPs, at par value of the shares. The ESOPs granted to Mr. X are exercisable as per the schedule set out below:

25% of the ESOPs shall be exercisable upon completion of 2 years by Mr. X with ABC
25% of the ESOPs shall be exercisable upon completion of 3 years by Mr. X with ABC
25% of the ESOPs shall be exercisable upon completion of 4 years by Mr. X with ABC
25% of the ESOPs shall be exercisable upon completion of 5 years by Mr. X with ABC

This means that once Mr. X has completed 2 years with ABC, he will be entitled to buy 50 equity shares of ABC at Rs. 10/share. Please understand that it is not mandatory for Mr. X to buy these shares once he is entitled to them. It is his option to buy the shares if he wants to. The policy will state the time period till when Mr. X can exercise this option. Such period is referred to as the “Exercise Period”. However, if not exercised, the option to buy the shares will lapse after the Exercise Period.

Q: What does vesting of an ESOP mean?

Under the Companies Act, 2013, ESOPs are required to have a minimum cliff period of 1 year i.e. for at least 1 year from the date of grant of the ESOPs, no ing can happen. Post the cliff period, vesting can be designed in any manner that a company/startup deems fit.

What is a cliff period in ESOPs?

A cliff is the time period between grant of ESOPs to an employee and vesting of the ESOPs. How does it matter?

A cliff is a very significant provision in ESOPs. It matters because in most start ups, the promoters tend to offer ESOPs to employee as part of the compensation in the offer letter. A promise to give ESOPs in an offer letter is not “granting” of ESOP and the 1year cliff does not start from this period. An ESOP is said to have been “granted” only once the company/startup has taken steps to put in place an ESOP Policy, such ESOP Policy is approved by Board and Shareholders of the Company and then the company/startup issues a Grant Letter summarizing terms of the ESOP Policy to the employee.

It is therefore important that if as an employer you are bringing employees on board with a promise to grant ESOPs, do not delay granting of the ESOPs, as by doing so, you would effectively be delaying the vesting timeline for your employee, who is anyway working hard for you from Day 1.

How does a cliff work?
The following illustration may help.
Let’s say Mr. X joined ABC Pvt. Ltd. (“ABC”) on September 1, 2014 and while discussing compensation, the promoter of ABC had promised him ESOPs with a vesting period of 1 year. Well, Mr. X is under the impression that the ESOPs would vest in him by September 1, 2015. However, ABC implemented its ESOP policy only on July 25, 2015. As a result X was granted ESOPs only on July 26, 2015. Since the law mandates a minimum of 1 year as vesting period, X will have no choice but to wait till July 26, 2016 to exercise the ESOPs. Almost 10 months later than what he had anticipated. It is, therefore, important for startups to set expectations with employees accordingly.

What is a typical vesting period in a company/startup?

Most incentives vest over a period of time or are subject to certain performance metrics. The vesting schedule is dependent on various factors, including the nature of your business, the compensation package being offered by your company vis-à-vis the market standards, the role of the person joining your company, etc. Under the Companies Act, 2013, it is mandatory to have a one year cliff period before the ESOPs vest. The typical vesting period is 4 years.

How does vesting work?
The following illustration may help:
On January 1, 2017, ABC Pvt. Ltd. (“ABC”) offers ESOPs to Mr. X, under the terms of which Mr. X is entitled to 200 equity shares of ABC, amounting to 2% of the paid-up share capital of ABC at the time of grant of the ESOPs, at par value of the shares. The ESOPs have 1 year cliff and a vesting schedule of 4 years.

As a result, the vesting shall occur as follows:

• 25% of the ESOPs shall vest on January 1, 2018
• 25% of the ESOPs shall vest on January 1, 2019
• 25% of the ESOPs shall vest on January 1, 2020
• 25% of the ESOPs shall vest on January 1, 2021

Q: Does the law prescribe any guidelines for vesting of ESOPs?

Under the Companies Act, 2013, ESOPs are required to have a minimum vesting period of 1 year i.e. a minimum of 1 year from the date of grant of the ESOPs.

LexGyaan: This is very important. Especially because most startups promise their employees ESOPs at the time of making them a job offer. However, it is almost 6-12 months (to say the least) from the employee joining the company that the startup actually puts together a policy and formally grants ESOPs to employees. As a result while the employer may have promised the employee a vesting period of 1 year, the vesting may in practice be longer because the employer took a long time to implement the policy. Confused?

Let’s say Mr. X joined ABC Pvt. Ltd. (“ABC”) on September 1, 2014 and while discussing compensation, the promoter of ABC had promised him ESOPs with a vesting period of 1 year. Well, Mr. X is under the impression that the ESOPs would vest in him by September 1, 2015. However, ABC implemented its ESOP policy only on July 25, 2015. As a result X was granted ESOPs only on July 26, 2015. Since the law mandates a minimum of 1 year as vesting period, X will have no choice but to wait till July 26, 2016 to exercise the ESOPs. Almost 10 months later than what he had anticipated. It is, therefore, important for startups to set expectations with employees accordingly.

Q: What happens if an employee leaves the company before the shares have vested?

See Attachment

Q: What does exercise of ESOPs mean?

As explained earlier, ESOPs are just “options” in the hands of employees. The shares don't automatically get issued to an employee upon the ESOPs being vested, and certain steps have to be taken by the employee in order to acquire the shares. Such action/step on the part of the employee is referred to as exercise of the ESOP.

Illustration: Upon completion of 2 years with ABC Pvt. Ltd. (“ABC”), ESOPs of 0.5% will vest in Mr. X. After 6 months from the date of vesting, Mr. X writes to ABC requesting for the 0.5% shares to be issued to him, thus exercising his right under the ESOP Policy.

It is advisable to have a form that the employee has to sign in order to exercise the ESOPs; this way there will be no confusion as to whether an employee has exercised his right or is just asking a question.

Exercise Period

Once vested, does the employee have a right in perpetuity to buy shares of the startup? The right of an employee to buy the shares is not in perpetuity and is usually subject to certain restrictions, including an Exercise Period and sometimes a lock-in-period.

The law does not prescribe any Exercise Period. Employers are free to choose an Exercise Period as they deem appropriate.

In practice, Exercise Periods are usually anywhere upward of 4 years from the vesting of the ESOPs. It is advisable to have a longer Exercise Period, so as to ensure that the employees have the option to exercise at convenience and when there are chances of liquidity. Imagine having to force an employee to buy shares of the company because the “Exercise Period” is running out and then have to wait and hope and pray that somebody buys their shares. That’s a risk for an employee. Therefore, the least the employer can do is provide for a longer Exercise Period. That way the employee has the option to exercise the right under ESOPs closer to a liquidity event.

Can a company buy-back shares acquired by an employee pursuant to exercise of ESOPs?

Yes, a company can buy-back its shares granted to employees under an incentive plan, provided the procedure for buy-back of such shares is in compliance with the Companies Act, 2013 and its rules. The ESOP Policy and Articles of Association of the company need to provide for buy back of employee shares.
Typically, a ESOP Policy would give the company the right to buy shares of the company, upon cessation of the employee's employment with the company, or where the employee joins a competitor of the employer company.
Buy back under the Indian Companies Act, 2013 is a long drawn process. Also the criteria for the company to be eligible to conduct a buy back are so many, that sometimes its not practical for a company to conduct a buy back. It is therefore advisable to provide for alternate options to buy back, such as purchase of shares by promoters.

Does the law prescribe a minimum or maximum Exercise Period?

No, the law does not prescribe any Exercise Period. Employers are free to choose an Exercise Period as they deem appropriate.

Once vested, does the employee have a right in perpetuity to buy shares of the startup? The right of an employee to buy the shares is not in perpetuity and is usually subject to certain restrictions, including an Exercise Period and sometimes a lock-in-period.

In practice, Exercise Periods are usually anywhere upward of 4 years from the vesting of the ESOPs. It is advisable to have a longer Exercise Period, so as to ensure that the employees have the option to exercise at convenience and when there are chances of liquidity. Imagine having to force an employee to buy shares of the company because the “Exercise Period” is running out and then have to wait and hope and pray that somebody buys their shares. That’s a risk for an employee. Therefore, the least the employer can do is provide for a longer Exercise Period. That way the employee has the option to exercise the right under ESOPs closer to a liquidity event.

Change in Exercise Period

Any change in terms of a ESOP Policy, including the Exercise Peiord, will require prior approval of the shareholders of the Company. Also, such changes cannot be prejudicial to the interest of the employees who have already been granted ESOPs.

Acquisition of Company/Startup during the Exercise Period

Most employees are worried about what happens to their ESOPs if a company/startup is acquired before the employees have had a chance to exercise their right to buy shares against vested ESOPs. The ESOP policy terefore should provide for consequences on vested ESOPs in case of an acquisition. Typically there would be some accelerated vesting in case of acquisition.

What is the general practice on Exercise Periods?

IN practice, Exercise Periods are usually anywhere upward of 4 years from the vesting of the ESOPs. It is advisable to have a longer Exercise Period, so as to ensure that the employees have the option to wait till a liquidity event in order to exercise their ESOPs. Why so? Because shares of a private limited company are not “marketable”. So, imagine having to force an employee to buy shares of the company because the “Exercise Period” is running out and then have to wait and hope and pray that somebody buys their shares. That’s a risk for an employee. Therefore, the least the employer can do is provide for a longer Exercise Period. That way the employee has the option to exercise the right under ESOPs closer to a liquidity event.

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Meet Our Team


ANISHA PATNAIK

Anisha is a corporate lawyer with over a decade of experience in M&A, Joint Ventures and PE/VC deals. Anisha is passionate about working with startups, travelling and good food! Anisha is based out of Mumbai and overlooks service delivery and operations.

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