All You Need to Know About ESOP Formation and Successful Launch

Successful Employee Stock Option Plans (ESOPs) often enable higher job satisfaction, employee retention, and increased productivity among employees and stakeholders at an org. Hence, having a clear blueprint of the process is critical for a masterful implementation. This article discusses the formation of ESOPs in India and pointers for a successful ESOP strategy. 

Process of ESOP Formation

Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 (“Rules”) and Section 62 (1) (b) of the Companies Act, 2013 are associated with the issuance of ESOPs. ESOP formation involves:

• Finding out whether other owners are accommodating.
• Carrying out a feasibility study.
• Conducting a valuation.
• Obtaining legal counsel.
• Funding the plan.
• Establishing a process for operating the plan.

The following steps describe the formation of ESOPs:

Step 1: Draft the ESOP

There are dozens of variations in the initial set-up of an ESOP, including financing, employee participation, vesting schedules, eligibility, and more. Therefore, it is crucial to determine the combination of options that will work best for your situation.

The first step is to prepare the draft for ESOP that follows the Companies Act, 2013 and Rules in India. Then, companies need to prepare the notice for a board meeting and resolve the draft during the session.

A week before the meeting, the draft is circulated among the directors. The draft includes schedules such as:

• A grant letter describes the options you would want to grant to the recipients.
• Form for delivering the exercise notice to the company when exercising a vested option.
• Option certificate documenting the exercise price, number of options, and vesting provisions.

Related: ESOP Terms 101: The MUST Know Terms for Every Founder

Step 2: Approval of ESOP pool and rules

The directors and shareholders approve the documents to adopt ESOP rules and set up the ESOP pool. ESOP resolution includes:

• Total number of options present in the ESOP pool
• Approval of ESOP rules
• Granting options to recipients at the board’s discretion
• Issuance of shares upon exercising options

Related: A Comprehensive Guide to Creating an ESOP Pool

Step 3: Grant the options

The draft is then sent to the board meeting to all the directors 15 days after the conclusion. Upon passing the board resolution, the MGT-14 form is filed with the Registrar of Companies.

Before the general meeting, all the shareholders, auditors, and directors are notified within 21 days. Under the ESOP, a special resolution is passed to issue shares to the eligible employees, officers, and directors in the meeting. In ESOPs, there are three terms associated with giving shares to the employees.

They include:

• Granting: Grant allows the company to issue stocks to its employees and inform them that they are eligible for ESOP. It will enable the company to choose the exercise price while providing the option to its employees.
• Vesting: Employees can apply for shares granted to them as part of their vesting. The vesting of an ESOP option shall take place at least one year after the option grant.
• Exercising: Employees can buy shares during the exercise period. If claims are issued after the exercise of the option, the company is free to specify the lock-in period. Regarding an ESOP granted to them, the employees are not entitled to dividends, voting rights, or other privileges as shareholders until the stock is issued following the exercise of the option granted to them.

Related: Who is Eligible to Receive ESOPs in India?

Pointers for a Successful ESOP Strategy

Here are some of the pointers that make for a successful ESOP strategy:

• First, the ESOP should elaborate on the growing needs of the company. The same should be shared with employees to set the right expectations.
• Then, a solid and effective communication strategy helps employees be more invested in the company’s growth and fosters trust and engagement.
• In addition to evaluating ESOPs, start-ups should consider their capacity for managing liquidity planning and execution, be it via cash settlements or an investor buying employee shares.
• Finally, the ESOP strategy should be flexible and accommodate change and communicate it transparently with the involved parties, such as the HR, corporate, finance, and legal departments.

Employee ownership has been shown to build healthier companies and employees highly satisfied with their jobs. In addition, start-ups benefit from ESOPs by retaining loyal, hardworking, and high-performing employees under difficult economic conditions.

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