Demystifying Employee Stock Option Plan Implementation for Startup Entrepreneurs

Wednesday October 19, 2011,

4 min Read


ESOPs Series for Startups by Legal Experts at NovoJuris It is nice to have you come back for more. Here are the Part I & Part II of the series to get the context.

In this post, we’ll cover the nuances for implementing an Employee Stock Option Plan (ESOP) through a Trust (formed under the Indian Trusts Act)

This is a little complex compared to the Plan directly administered by the Board. Here’s an overview of how this works:

  1. A Trust is formed under the Indian Trusts Act, and the Trust Deed is registered with the jurisdictional Sub-Registrar. In Karnataka, a stamp duty of 1% of the value of shares (including premium) is applicable.
  2. The ESOP Trust receives stock either from company by way of fresh allotment or or one of the shareholder/founder may transfer his shares.
  3. In order to purchase the shares, the Trust can obtain a loan from a financial institution or the company can provide the loan as well. There is a specific provision in the Companies Act, which permits such a loan. (Sec. 77(2) (b) and (c) )
  4. The ESOP Trust then allots shares to employees on exercise of their right in exchange of cash and repays its loans.

Here are some teaser questions that your advisor needs to help you with. If the shares are issued at a premium does the premium remain with the Trust? Can the Trust also manage other activities like provident fund? Who needs to be Trustees? How do the Trustees and the Board of the Company work in tandem? What powers need to be granted to the Trustees?

This series on ESOP is meant for startups but just an additional point in the passing, for a company listed on stock-exchanges (which are governed by SEBI’s regulations): SEBI guidelines do not mention about ESOP Trust and thus creation of a Trust to administer the Plan is optional. SEBI guidelines also do not specify any accounting principles to be followed. A committee appointed by SEBI had recommended that since this is a consolidation issue rather than an ESOP issue, the ESOP Trust should be consolidated with the company under Accounting Standard 21 and the existing ESOP guidelines should be applied by the consolidated entity.

Below is our attempt to outline the how-to points. We believe that the company will need a smart team to help implement this, could be in-house or outsourced.

  1. Structure the ESOP Trust Deed (a Private Trust formed under the Indian Trust Act, 1882).
  2. Shares of the company can be held by the Trustees is held as beneficial owners. Hence Form 22-B declaring beneficial ownership has to be filed with ROC. (Sec 153 of Companies Act).
  3. Board of Trustees is controlled by the Company (indirectly by being nominated as trustees).
  4. Company may give loan to the trust to buy shares (earmarked for ESOP) (U/s 77 of Companies Act).
  5. Trust uses the funds to buy shares of the Company.
  6. Employees of the Company are granted Options. Decision to grant Options is controlled by the Compensation Committee of the Company.
  7. On exercise of the Options, the Trust transfers shares (held by it) to the employee.
  8. While transferring the shares to the employees by the trust, the Share Transfer Form (Form 7B) has to be executed by the Trust and the employee.
  9. The share transfer form has to be approved in the Board Meeting (BM) of the company and then the employee becomes a shareholder of the company. After which they are issued share certificates and the Register of Members is updated accordingly by the Company.
  10. If the options lapse due to separation, the options remain with the Trust.
  11. The cash received on exercise (by the employee) is used to repay loan taken by the Trust.

The idea of this Series is not to over-whelm the startup entrepreneur but to sensitize him on the various avenues available.

In the next post, we plan to cover aspects to keep in mind if there is an investment by a VC.

Disclaimer: This article is for informational purposes only and is not a legal advice or opinion.

About NovoJuris

Sharda Balaji founded NovoJuris with the realization that technology innovations are fast outpacing the legal framework. NovoJuris counts over 200 small and medium business and over 10 investment houses as their customers over the last 3 years. NovoJuris values a culture of providing professional legal help and obsesses about the success of their customers. The management team at NovoJuris brings over 30 years of experience in technology and law into practice. Do check out their website for further details.

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