Employee Stock Option (“ESOP”) is an opportunity for the companies to let its employees becomes the shareholder and therefore ESOP is generally used by the Startups where the employees are given an option of becoming a shareholder in the company. The first step to begin with the ESOP Scheme is to decide the number of ESOPs that the company will offer or the percentage of ESOPs. This process is known as the creation of a pool of ESOPs. Board resolution is to be passed by the company so as to create an ESOP pool. The next step is defining the rules and regulations in the ESOP Policy. After framing ESOP Policy, company grants the ESOPs to its employees by issuing the grant letter.
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| Serial No. | Clause | Content |
|---|---|---|
| 1 | Grant Date | Grant Date is the date when the ESOPs are actually granted to an employee. It is generally a joining date or increment date. It is the vesting start date as well. |
| 2 | Vesting Schedule | It is the time period when an employee becomes eligible to exercise the options in the company. The general vesting schedule followed by the companies are four years with one year cliff. |
| 3 | Exercise Price/Strike Price | It is the price which employees need to pay at the time of exercising the ESOPs. In the initial years, startups tend to keep face value of share as its exercise price. |
| 4 | Exercise Period | It is the time period when employees need to exercise its options after completion of vesting period. Startups can keep liquidity event as its exercise period as well. |
| 5 | Termination of employment | This clause defines the treatment of vested and unvested options at the time of termination of employment. Generally, companies keep the difference in treatment with the reason of termination which can be “with-reason termination” or “without reason termination”. |
| 6 | Accelerated Vesting | Accelerated Vesting is the accelerated or fast way of vesting for any specific class of employees. |
| 7 | Conflicts, Dispute Resolution and Jurisdiction | Clauses to solve the future conflicts between employer and employee with respect to ESOPs. |
| Dos | Don'ts |
|---|---|
| ESOP Policy implementation requires the approval of shareholders in a general meeting so every company issuing ESOPs must have to take this approval. | Company should not delay in the grant of ESOPs to its employees as it becomes a problematic situation to grant it at later stage retrospectively. |
| Company must follow the same vesting schedule for the same class of employees in order to avoid any future issue. | Companies should avoid introducing its founders through ESOPs grant as they may not be shareholders in the initial years in the captable so creates the issue. |
| Always commit ESOPs in the multiple of your existing price/share so as to avoid fraction issues consistently. | Companies should avoid writing their employees as shareholder till the time they exercise the options. |
| ESOP Policy | Grant Letter |
|---|---|
| ESOP Policy is the once for the lifetime which is applicable to all the employees eligible for ESOPs. | Grant Letter is employee specific which is to be issued for all the grants. |
| ESOP Policy defines the rules and regulations with respect to ESOPs. | It defines the employee-specific clauses. |
| For regulating the scheme, ESOP policy is the primary document that is to be prepared. | It is an employee-specific letter that is to be issued for granting ESOPs to employees. |
Startupsshould create an ESOP pool from the very beginning immediately after its formation.
If a company feels the requirement of increasing the pool, then it can do so at a later stage after obtaining the required consent from its shareholders.
ESOP pool is just for the full time employees of the company. But for the advisors a company has to create an advisory pool and it can issue shares to the advisors from that specific pool.
If the termination is without cause, then the employee is free to keep the vesting options along with him, if he wants to and become the shareholder of the company.
Basic procedures are required to be carried out that is generally followed for other similar allotments after receipt of exercise amount.
The money of ESOP when sold is transferred to the bank account of employees.
ESOP Scheme covers the provisions of merger, acquisition or acquihire which generally defines that an ESOP holder shall become the shareholder or ESOP holder of new company.
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