We recently conducted a webinar on “Legalities of Structuring Incentive Plan for Employees and Advisors” in collaboration with Social Alpha. For your ease and convenience, we bring to you a few takeaways from the same.
There are numerous incentives which one may use, such as phantom shares, sweat equity, shares and stock options, how do you choose which one would work the best? There are numerous factors to be considered such as: who gets the incentive, how long has the person been employed with you, purpose behind the incentive, is the person getting any additional cash consideration etc. Let us examine how each type of stock incentive works:
Sweat equity
Allotted to employees/directors for considerations other than cash such as technical know-how or intellectual property.
Value being added by the said employee should be certified by a registered certifier.
Have a lock-in period of 3 years.
Can be allotted for consideration other than cash or for cash. Can also be allotted in tranches.
It is always preferable to allot a certain number of shares rather than a certain percentage of equity.
Tax incidence may increase if allotment is done in tranches.
Checklist for allotment of shares:
Co-Founders’ Agreement/Advisory Agreement.
Increase the Authorized Share Capital.
Board Resolution and Shareholders’ Resolution.
Waiver of Existing Shareholders’ Rights, in case of rights’ issue.
Valuation certificate and new bank account, in case of private placement.
Phantom Shares/Stock Appreciation Rights (SARs)
Holder has a right to the appreciated value of the stock at a future date and upon completion of a fixed milestone.
Holder only gets a cash pay-out and never becomes a shareholder.
Liquidity is important as company has to make cash payments to the holder.
Enforcement of the same may be difficult.
The cash consideration received is taxed as salary in the hand of the employee. Employer can utilize this as deduction.
Checklist for SARs :
SARs Scheme/SARs Agreement.
Board Resolution
Get approval from investors, if they have veto rights.
No filings required.
Stock Options
Holder has a right to buy the shares of the company at a pre-determined price, on a future date and upon completion of a fixed milestone.
Allotment of stock options can be time based (vests after a certain period of time) or milestone based (vests upon the rolling of product).
If a company wants to allot Employee Stock Options or ESOPs then they can only allot to employees, directors or promoters in case the company is a start-up.
Non-statutory stock options can be given to all.
ESOPs have a one-year cliff period.
Employees have to pay money to buy shares in the company.
Tax incidence is on the difference between the fair market value of the shares and the consideration paid by the employee.
Deferred for Startups with tax exemption to earlier of (a) 5 years from the date of exercise, (b) employee resigning from the Company, or (c) employee selling the shares.
Checklist for Stock Options:
ESOP Policy/Stock Option Agreement
Grant Letter (mandatory for ESOPs)
Board Resolution
Shareholders’ Resolution (mandatory for ESOPs)
If Investors, check for veto rights – get approval
No filings required
Partly-Paid up Shares
Shares are allotted against payment of part consideration
Rights of the shareholder shall only be available with respect to amount paid.
Taxability would arise at the time of allotment of shares.
The difference between the fair market value and the consideration paid by the employee would be taxed.