Fundamentals of ESOP- Part II

1. How easy or difficult is it for a company to start making Grants?

Granting is the first stage in the ESOP process. To make a grant, all the company needs to do is create an Employee Stock Option Plan. The Plan needs to be adopted by the shareholders of the company by way of a special resolution. Once the Company adopts an Employee Stock Option Plan, the Board can start making Grants.

While making a grant, a number of questions arise that include:

  • What kind of ESOPs should I grant – where individuals have a right to acquire shares or simply a right to participate in the company’s growth?
  • Should there be any pre-conditions attached to ESOPs – eg. time based, performance based or based on listing / strategic investments?
  • Which individuals should be granted ESOPs – all employees or just a handful?
  • What should be the quantum of ESOPs to be granted to these individuals?
  • And some more.

Once you arrive at the answers to these questions, the ESOP documentation is executed with each of the Grantees. The employees receive a grant letter that specifies the terms and conditions applicable to the options granted under a particular ESOP plan of the company.

Grants made under Plans that are not adopted in this manner are not valid. The Grantee cannot get any legal rights under such grants and the company is not bound by such grants.

2. Can an Option Grant be backdated?

Typically, backdating any document is fraught with legal risks and can be cancelled / avoided.  This will particularly be true if by back-dating you are seeking to get around some legal requirements. For instance, the law requires that every grant is subject to a one year cliff, i.e., a minimum of one year must pass for Options to vest. This requirement cannot be avoided by back-dating Options.

3. Does being granted an Option guarantee that the Grantee will become a shareholder?

No, being granted an Option is by no means a guarantee that the Grantee will become a shareholder.

Firstly, the Options need to vest. Only upon the Vesting Conditions being satisfied, will the right to acquire the Shares fructify.  

Secondly, the Grantee must exercise the Options as per the terms and conditions set out in the Option Plan. Some Option Plans provide for free exercise of vested Options. Other Plans provide for exercise only as part of buy-back programmes, post a listing of the equity shares or as part of an M&A.

4. What happens when a Grantee dies or suffers other forms of disability that prevents her or him from working?

Globally, the practice is that vesting stops when a Grantee stops working with the company. The Options need to be earned in the same manner as remuneration. However, the law in India provides that grants that are made vest if a Grantee suffers an untimely demise or any other form of permanent disability.

5. Are Options transferable? If they are not transferable, what happens to the Options on the demise of a Grantee?

Typically, Option Plans provide that a Grantee cannot transfer the Options that are issued to the Grantee.  However, upon the untimely demise of a Grantee, all Options granted automatically vest in the legal heirs of the grant. To facilitate this, companies typically ask the Grantee to nominate the legal heir, i.e., the person who will be considered the Option holder. The Option holder may then exercise the Options as provided for the ESOP Plan.  

6. Are every employee entitled to receive Options?

Options are granted strictly at the discretion of the company. No employee can ask for Options to be issued to her or him as a right.

7. If Options are granted to me, can my employment be terminated?

Grant of Options does not guarantee employment in any form. Your employment may be terminated by the Company at any time in accordance with the terms of employment. Typically, vesting stops upon employment ending, whatever be the reason for the termination of the employment.

8. What happens to Options when I am transferred to a different group within the same company or a different company of the same group?

These are practical questions and need to be addressed in the Plan and the terms of the grant.  The simple answer is that if the Plan is silent, the grant continues if you are transferred to a different group within the same company.  In the case of transfers to other group companies, the Options will lapse (unless the Plan provides otherwise). The nature of the grant may also have an impact on the Options in such situations. 

Planning, administering and managing ESOP requires a deep subject knowledge, and not to mention also involves huge administrative costs. Adequate documentation and transparency tend to make this process smooth for you and your personnel.  

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