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Employee Stock Option Plans or ESOP for short have been used by many companies to great avail. There are stories of companies eg. Infosys using ESOPs to create exceptional wealth and loyalty among employees. One such story involves a Driver exercising their right to cash out ESOPs and becoming a millionaire in the process. Yes, you read it right! A driver and a millionaire in the same sentence.
Another story follows Google hiring one of our Indian fellows with an annual package of 1.2 Crore rupees. However, the conditions of his employment stipulated that half his salary was in the form ESOPs. Startups can use these plans after registering their company to attract and retain talented employees who can contribute towards the swift growth of the organization.
Technically speaking, ESOPs are the plans in which the employees get the right to buy a fixed amount of shares(determined by Employer) at a predetermined price in lieu of their salaries. Employees can only exercise the right to buy shares after a fixed period of time known as the Vesting period. Offering the prospects of being part of the big fortunes of the company gives a sense of ownership to employees. Tapping into this sense of ownership employees are willing to work harder. This generally occurs because employees realize their financial growth is directly linked to the company performing well.
Let’s take an example of Alpha Private Limited.
Alpha Private Limited is a recent startup and is looking for talented employees. The employees demand a remuneration of Rs. 15 lakh per annum as they are experts in their area. The company, however, can only afford to pay Rs. 10 lakh per annum. So in a pursuit to not lose two experts, the company allocates ESOPs to both employees with a vesting period of 4 years and hires them with 10 LPA salary.
The company did not lose two great prospective employees who will definitely accelerate the growth of the company and they did so while only investing the least possible amount of current assets. The early-phase start-ups are incapable of paying highly competitive salaries and hence use ESOP as a tool to retain employees. ESOPs are basically a promise to the employees that when the company has grown because of your efforts you will have a right to be a part of its fortunes.
According to the Companies Act, 2013 under Section 62(1)(b) provides that a company may, subject to compliance with conditions as prescribed under the Rules (in case of unlisted company) and SEBI Regulations (in case of listed companies), offer shares to the employees under a scheme of employees’ stock option.
With accordance with the Companies (Share Capital and Debentures) Rules, 2014 only the following employees are NOT eligible for ESOP
ESOP is a great tool to align the objectives of new prospective employees with the company shareholders i.e. Growth of the Company. Early-phase startups are almost always at a dearth of resources and the prospect of future resources can act as not only a retention tool but also as an attraction tool for future employees.
Let’s look at some of the benefits ESOPs have for startups.
However, despite all their cost-cutting and employee retention qualities, there are some drawbacks and challenges to implementing ESOPs.
After an extensive study into ESOP’s exciting prospects and startups using it as a fashionable trend to include employees in the growth of the company sounds intriguing. For early-phase startups, ESOPs have come forward as a great cost-cutting tool and the benefits have reaped humungous rewards for many private limited companies among others.
At LegalRaasta we specialize in company registration for startups. If you are just starting out with forming your company, There are many things to consider to ensure smooth day-to-day operations. These include documentation, Compliances as well as Business Income Returns Filing.
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