6 Changes in the Revised ESOP Regulations

Employee Stock Option Plans (ESOPs) have an impact on a company’s human resource availability in key positions, the financial statements and the share capital. Hence, their regulation and adherence to the same are important for employers.

Employee Stock Option Plans (ESOPs) are regulated by the following:

• Companies Act, 2013
• Securities Exchange Board of India (SEBI) through Share Based Employee Benefits (SBEB) Regulations (2014) and Sweat Equity Regulations (2002)

On July 8th, 2021, an Expert Committee formed under SEBI released revised guidelines on SBEB and Sweat Equity Regulations. The objective of such changes is to update and align the existing guidelines to global standards, practicalities in the industry and increase their robustness.

What are the major changes that have an impact on ESOPs?

1. Definition of the term ‘Employee.’

The scope of the term ‘employee’ is relevant in ESOPs since it influences the eligibility and issue of ESOPs. Presently, the term ‘employee’ refers only to a permanent employee. The changes that have been proposed are as follows:

• Removal of the word ‘permanent’.
• Inclusion of employees who are on probation or deputation.
• Inclusion of employees hired on a contract basis or ‘gig workers’.

This move has broadened the eligibility criteria for receiving an ESOP. Considering the latest practices where hiring freelancers is on the rise, this is a significant change.

2. Grant Date and Vesting Period

Grant date and vesting period are significant instances in the journey of an ESOP. The expert committee has suggested changes pertaining to these instances.

Grant date: According to Regulation 2(1)(n) of the current SBEB Regulations, the grant date is the date on which the grant is approved. The proposal seeks to align the grant date with the applicable accounting standards.

Vesting period: The regulations applicable to vesting in case of death or permanent incapacity have been relaxed in the new guidelines. The minimum vesting period of one year will not be applicable in such cases, i.e. the options shall vest on the date of death or permanent incapacity. The company is expected to draft a suitable policy in this regard while ensuring compliance with the relevant labor laws.

3. Sweat Equity Shares

The regulations pertaining to sweat equity shares are aligned with those of SBEB. The following specifications need to be mentioned:

• Objective
• Maximum limit on the sweat equity shares that can be issued
• The lock-in period for investors and pricing formula, which are to be aligned with the SEBI Issue of Capital and Disclosure Requirements Regulations, 2018.

4. Cessation of Employment

In case of cessation of employment due to retirement, business closure, lay-offs, or similar measures, all the ESOPs, stock appreciation rights, and other such benefits that are granted but not vested will expire. The proposal clarified that cessation of employment due to retirement does not deprive the employee of the above-mentioned benefits. They would continue to vest as per the schedules drafted at the time of granting ESOPs. This is, however, subject to applicable laws and company policies. For more information on drafting company policies for ESOPs, click here.

5. Other points

Subject to the approval of shareholders by a special resolution, the revised guidelines allow companies to:

• Switch between the trust route (where the company forms a trust for ESOP operations) and the direct route (without a trust). However, Independent Directors (IDs) cannot be appointed as trustees. Click here to know more about IDs and ESOPs.
• Alter the terms and conditions of an ESOP that is already issued but not exercised, provided that such changes are not prejudicial towards employees.

6. Amendments 

On August 6th, 2021, a fresh set of regulations were released by SEBI to make operations and governance easier for technology-driven startups. Here is a snapshot of the key changes proposed:

• The existing Share Based Employee Benefits (SBEB) Regulations 2014 and Issue of Sweat Equity Regulations, 2002 are merged into a single regulation – Share Based Employee Benefits and Sweat Equity, 2021.
• The annual ceiling on sweat equity shares issued is 15% of the paid-up capital. The overall ceiling is capped at 25% of the paid-up capital. Companies listed on the Innovators Growth Platform (IGP) enjoy an additional 25% (totally 50%) of the paid-up capital.
• The minimum lock-in period for promoters has been reduced to 18 months from three years and 6 months from 1 year for other investors. This relaxation eases the exit path for promoters and investors.

The revised guidelines are beneficial to all the stakeholders involved in ESOPs. They provide more legroom for companies while retaining the interest of employees and encourage transparency and ethical practices.