Employees or human resources or the workforce of a startup plays an important role in the growth of a startup. A startup which takes care of its employees ensures its smooth functioning. For this it is extremely important that the employers give the employees their due credit for their efforts and hard work, and appreciate the creativity of the employees in the form of rewards and lucrative offers. Such practices boosts the morale of the employees, motivates them and encourages them to perform in a better way for the growth of the company. This also helps in retaining the employees for a long term. If a startup wishes to achieve the above, then the best way of doing so would be to provide for an Employee Stock Option Plan popularly called as ESOPs.
Meaning and benefits of ESOPs:
In the initial days of a startup, it might be requiring capital or funds. Such requirements can be met by offering or selling shares of the startup or company to the employees. It is a plan or scheme or mechanism through which some shares of the startup or company are sold to the employees at a price less than the market price or at a fixed price for a specific time period. It gives the employees an equal right in the profit sharing of the startup or company. It enables the employees to have a small ownership in the startup or company. As the employees own the stocks they feel responsible for the performance of the startup or company. This helps in determining the performance as if the employees of the startup or company perform well then the value of shares of the startup or company rises and if they don’t then the value of the shares will fall. Further this is generally given as a right to the employees making them feel as an important part of the startup or company. Also it is optional for the employees to subscribe to ESOPs i.e. they are not under any obligation or compulsion to buy these fixed number of shares and they are free to reject the offer if they wish to. It also helps in retaining the employees as the ESOPs scheme provides for a lock-in period for the employees. So If an employee subscribes to ESOPs then he has to serve the startup or company within the prescribed lock-in period and cannot quit it.
Legality of ESOPs:
ESOP’s are governed by Section 79A of the Companies Act 1956, Section 54 of the Companies Act 2013, Employee Stock Option Scheme and Employee Stock Purchase Scheme issued by the SEBI in 1999(Amended in 2002, 2003 and 2013 respectively).
Issue Price:
The price on which the stocks are given to employees of the company can be of three types i.e the market price, preferential price or pre-determined and undetermined price. Firstly, the startup or company can issue ESOPs to the employees at market price wherein the prices of such issued shares to the employees are also mentioned in the stock exchange. Secondly, it can issue ESOPs at preferential price or pre-determined price wherein the prices of such ESOPs are lower compared to the market price i.e. they are discounted or cheaper than the ESOPs issued at market price. Thirdly, a startup can issue ESOPs at any price it wishes subject to the condition that such shares should not be listed on the respective stock exchange i.e it can be undetermined. Such a determination of prices is as per the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.
Types of ESOPs:
The various types of ESOPs related schemes are as follows:
- Employee stock option scheme.
- Employee stock option plan.
- Stock appreciation right or phantom equity plan.
- Restricted stock award.
- Restricted stock unit.
Important Clauses in an ESOP scheme
Objectives Clause:
This clause provides information relating to the objectives of the plan or scheme of an ESOP. It showcases the rewards which the employees will receive for subscribing to ESOPs. It also boosts the morale of the employees of the startup or company by making them feel as owners of the startup or company. It creates a sense of responsibility of the employees towards the startup or company.
Terms Clause:
This clause provides details regarding the tenure or duration of an ESOP scheme in which it would be operative or effective. It can also provide details regarding the extension of an ESOP scheme.
Eligibility Clause:
This clause provides details regarding the eligibility of an employee for receiving a grant or vested option. Eligibility criteria can include length of service i.e. service years determining seniority, performance of the employee.
Equity Shares or Allotment Clause:
This clause provides details regarding the number of or quantity of shares that are being allotted to the employee and also specify the pricing of such shares. It provides details about the maximum percentage of shares to be issued under the ESOP scheme.
Grant of Options Clause:
This clause provides details with respect to the procedure that is to be adopted by the startup or company while issuing or granting shares under the ESOPs scheme. It also provides for the date on which such grant can be made and the determination of the price of such a grant of shares and by whom such price would be determined, maximum acceptance time for such a grant by an employee.
Vesting of Options Clause:
This clause provides for the procedure through which an employee can apply for shares of the startup or company. It provides for a time period within which an employee has to apply for the shares of the startup or company.
Exercise and consideration Clause:
This clause provides details regarding exercise price and period. Exercise price is basically the payment or consideration that is being paid by an employee who wishes to exercise his right to hold the shares of the company via the ESOP scheme. The exercise period is the time period or duration after vesting of shares within which an employee must exercise his right to apply for the shares of the company and make all the required payments in this regard.
Rights Clause:
This clause explains all the rights of an employee opting for ESOPs after the payment is completed for it. It provides for the various safeguards and protection that is available to him once he subscribes to the ESOPs of the startup or company.
Amendment Clause:
This clause provides for the amendments or modifications or alteration which may be carried out to the ESOPs mechanism of the startup or company. It can specify the persons who have the right to amend the ESOPs like for e.g. it can be a director or board of directors or any other appropriate person.
Termination Clause:
This clause provides details as to the procedure to be adopted if an ESOP is terminated before its prescribed expiry period. It provides for the reasons and circumstances under which an ESOP can be terminated before its lapse date and the person so authorized to terminate an ESOP.
Dispute Resolution Clause:
This clause provides details regarding the procedure to be adopted while resolving any disputes which might arise during the operation of ESOPS. It provides the ways that are to be adopted while resolving the disputes which can be either mediation or arbitration. It can also provide for a pre-appointed mediator or arbitrator.
Conclusion:
With respect to the above, it is very important to have a well drafted ESOP which is extremely informative and detailed. All the above discussed clauses should form a part of the ESOPs along with any other vital information required to be added in the ESOP scheme. Every entrepreneur who wishes to start his own startup or company should focus on a well drafted ESOP scheme. He should consult a startup lawyer for the drafting of the same. A startup lawyer can ensure that all the required legal compliances with respect to startups have been adhered to. Such a startup lawyer can not only help you in drafting and vetting of legal documents(contracts and agreements) but he can also be helpful in various stages like getting investors in your startups, startup finances, getting angel investors or angel investment companies providing angel capital or angel money, crowdfunding or other funding opportunities for startups . So if you are an entrepreneur with a startup plan, seeking consultation of a Startup Lawyer who has all round knowledge with respect to startups, is a must.
