esop and sweat equity

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good PPT. very informative and educative.

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EMPLOYEE STOCK OPTION SCHEMECONCEPTUAL BASIS OF ESOP: History: The concept was developed in the 1950s and usually credited to Louis Kelso; In 1916, Sears Roebuck decided to fund its pension plan primarily with company stock. The concept was that the employees’ ownership of Sears stock was a good retirement benefit for them and at the same time, an excellent way to motivate employees to improve the company’s profitability In U.S. it is estimated that 9% of all stock is held in different forms of ESOP


DEFINITIONS Section 2(15A): Employee Stock Option means the option given to the whole time directors, officers or employees of a company, which gives such directors, officers or employees the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a pre determined price. The Section 81 read with various SEBI Guidelines speaks about ESOP; Securities Exchange Board of India framed the SEBI (Employee Stock Option Scheme and Employees Stock Purchase Scheme) Guidelines, 1999 and has been amended thereafter from time to time;


OBJECTIVES OF ESOP Attracting critical skills Employee feeling of ownership and commitment Creating additional wealth for employees A method to supplement social security benefits To retain employees or groups apprehended of high turnover To introduce a performance management system without incurring full cash out flow As a possible hedge against hostile controlling interest To enforce corporate governance Different Types of ESOP: Employee Stock Option Scheme (ESOS): the company grants an option to its employees to acquire shares at a future date at a pre-determined price. Eligible employees are free to acquire shares on vesting within the exercise period. Employees are free to dispose of the shares subject to lock-in-period if any. Generally exercise price is lower than the prevalent market price.

Contd…. : 

Contd…. Employee Stock Purchase Plan (ESPP): This is generally used in listed companies, wherein the employees are given the right to acquire shares of the company immediately, not at a future date as in ESOS, at a price lower than the prevailing market price. Shares issued by listed companies under ESPP will be subject to lock-in-period, as a result, the employee cannot sell the shares and/or the employee has to continue with the employer for a certain number of years. The company offers shares to employees as part of a public issue . Share Appreciation Rights (SAR)/ Phantom Shares: Under this scheme, no shares are offered or allotted to the employee. The employee is given the appreciation in the value of shares between two specified dates as an incentive or performance bonus, that is linked to the performance of the company as a whole, as reflected in its share value.

Flexibilities in Application of ESOP : 

Flexibilities in Application of ESOP Stock Appreciation Rights: employees are given "Rights" to a particular number of shares at the market price on the date of allotment of Rights. Shares are physically not transferred in the names of employees nor do they give any money to buy the shares. These rights are redeemable in instalments at regular intervals at the market price prevailing on the date of the redemption. Employees are given the appreciation benefit. Options to employees to buy shares at the average of the last six months market price and offer soft loans from the company to buy these shares, These options are given in instalments at intervals of one or two years. Thus, there is no lock in period Offer the option of warrants which are converted into shares at a fixed price at the option of the employee. In this, the warrants are converted into shares at far less price than the market and this makes the scheme attractive.

Salient Features of ESOP : 

Salient Features of ESOP An option is given to employees to acquire equity shares (or other convertible securities) in the company after a future date but the price is fixed in advance; The employee has the choice to decide whether to acquire the shares/convertible securities or not; In case the employee opts for the shares, he has to exercise an option and pay the agreed price; After the lock-in period (if any) the employee can sell the shares in the market and realize the gain; The employees holding stock options do not have the right to receive dividend or vote or enjoy any other privileges of a shareholder till the shares are actually issued on exercise of option, after the completion of vesting period; The options granted to the employees are not transferrable to any other person. The option granted to the employee cannot be pledged, hypothecated, mortgaged or otherwise alienated in any other manner


UNDERLYING PROCEDURE AND APPLICATION OF ESOP Eligibility He should be an ‘Employee’ As per the definition of ‘Employee’ given in the SEBI guidelines, it includes directors and whole time directors An employee who is a promoter or belongs to the promoter group is not eligible to participate in ESOP Recently the SEBI has permitted the nominee directors appointed by the financial institutions, banks, etc., on the board of directors of the assisted companies to participate in ESOP subject to the provisions of the contract or agreement entered in to between such director and the nominating institution.

Disqualification : 

Disqualification An employee who is a promoter or belongs to promoter group A director who either by himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company shall not be eligible to participate in the ESOS. (Promoter is a person(s) - who is in over all control of the company - who is instrumental in the formation of the company - is named so in the offer document Promoter group includes immediate relatives of the promoter i.e. spouse, parent, brother, sister or child of the person or of the spouse)

Various Stages in The ESOP Process : 

Various Stages in The ESOP Process Grant – it means issue of stock options to employees under ESOP. The employees may be required to pay an upfront amount at time of grant of options, depending upon the provisions of the scheme framed by the company. The said amount is adjusted when the shares are allotted on exercise of option. Vesting- Vesting means the process by which the employee gets the right to apply for and be issued shares of the company under the options granted to him. Till the vesting takes place, the employee does not have right to apply for the company’s shares. Upon vesting, the employee gets an unfettered right to apply for the issue of shares. Vesting Period- it means the period during which the vesting of the options granted to an employee takes place. The SEBI guidelines provide that the vesting period shall not be less than one year from the date of grant of options. Vesting percentage- it refers to that portion of the total options granted, which an employee is eligible to exercise. In other words, vesting of the entire lot of options granted can take place either in one stokes at the completion of a fixed period or it can be staggered or phased vesting. Exercise period- it means the time period after vesting within which the employee should exercise his right to apply for the shares, otherwise the vested options would lapse. This period starts from the date of vesting of options. Exercise- it means making of an application to the company by an employee together with the requisite amount, for issue of shares against the options already vested


ESOP AND UNLISTED COMPANIES Issues Related To Unlisted Company’s ESOP Scheme The main issue regarding the ESOP scheme in an unlisted company is that how does the employee make money on his shares? For this some sort of a liquidity event is needed. Liquidity events could include: Initial Public Offer Acquisition Equity investment Buyback by the company Buyback by the Employee Welfare trust Purchase by the promoters/founders till shares are issued to him on exercise of the option SEBI Reform committee recommended that ESOP shares issued by an unlisted company may be allowed to get listed after the IPO subject to fulfilment of the following requirements: Ratification of the resolution passed for issuance of ESOP Disclosures in the offer document

ESOP and Listed Companies : 

ESOP and Listed Companies The procedure for formulating an ESOP scheme in a listed company should be in accordance with the guidelines of SEBI SEBI (Employee Stock Option Scheme And Employee Stock Purchase Scheme) Guidelines, 1999 regulates the ESOP in Listed Companies. Compensation Committee No ESOP can be offered by a listed company unless a Compensation Committee is constituted Committee consist of majority of independent directors Duties: administer and supervise the scheme formulate the detailed terms and conditions of the scheme frame policies and system to ensure that there is no violation of SEBI (Insider Trading) Regulations,1992 and SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulation, 1995

Shareholder’s Approval : 

Shareholder’s Approval By way of Special Resolution in a general meeting A separate resolution in general meeting is required in case of grant of option to a subsidiary or a holding company to an identified employees, during any one year, equals to or exceed 1% of the issued capital of the company at the time of grant of option. The next steps are: Exercise of Option Allotment of Shares Sale of Shares Listing of ESOP Shares arising out of ESOP shall be listed immediately upon exercise of option, in a recognized stock exchange where the securities of the company are listed.

Slide 14: 

ESOP Procedural – Flowchart Drafting of ESOP Scheme Consideration of ESOP Scheme by Board & proposing constitution of ‘Compensation Committee’ (CC) Consideration of ESOP Scheme in EGM & authorisation for Constitution of CC. Meeting of CC - determination of eligibility criteria, exercise price, vesting Period, exercise period etc. Communicate – Grant of options to Employees Acceptance of Grant Communicate – Vesting period Employees exercising options – fwdng application to CC Hold BM for allotment of Shares intimating allotment to Concerned Employee Entry into Register of Members Reporting to: ROC RBI, if applicable Convey allotment to CC


ADVANTAGES, DISADVANTAGES & LIMITATION OF ESOP Advantages Awareness of company success Employee commitment and satisfaction Spurs change Heightened decision making Encourages reengineering Disadvantages Stock markets are highly volatile ESOP can increase the financial risk of employees in case they over-invest in their company The difference between the ‘fair value’ and the discounted ‘exercise price’ has to be treated as employee compensation and as such the same has to be debited to the profit and loss account of the company In case the ESOP scheme has a lock-in-period after allotment of shares, then it leads to blocking of funds. ESOP leads to dilution in the shareholding percentage of other shareholders including the promoter group.


CRITICAL ANALYSIS OF ESOP – CHALLENGES FACED & POSSIBLE SOLUTIONS The Challenges Abound ESOP as Employee’s Right Associated Cement Staff Union, Mumbai v. State of Maharashtra & Ors A study by the International association for Financial Planning found that 66 percent of financial planners stated that employees do not understand the risks of stock based compensation plans. The four challenges are Technical Psychological Ideological Structural Clearing The Pitfalls ESOP in a Bearish Market Some Solutions


SWEAT EQUITY SHARES PROVISIONS IN COMPANIES ACT ON SWEAT EQUITY Section 79A of the Companies Act, 1956 authorizes the issue of sweat equity shares subject to certain conditions. Section 79A: (1) Notwithstanding anything contained in section 79, a company may issue sweat equity shares of a class of shares already issued if the following conditions are fulfilled, namely- (a) the issue of sweat equity shares is authorized by a special resolution passed by the company in the general meeting; (b)the resolution specifies the number of shares, current market price, consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued; (c)not less than one year has, at the date of the issue, elapsed since the date on which the company was entitled to commence business; (d)the sweat equity shares of a company, whose equity shares are listed on a recognized stock exchange, are issued in accordance with the regulations made by the SEBI in this behalf: Provided that in the case of a company whose equity shares are not listed on any recognized stock exchange, the sweat equity shares are issued in accordance with the guidelines as may be prescribed. (2) All the limitations, restrictions and provisions relating to equity shares shall be applicable to such sweat equity shares issued under sub-section (1).


TO WHOM SWEAT EQUITY COULD BE ISSUED Sweat equity shares by definition could be issued only to the ‘employees or directors’ of the company incorporated under the Companies Act, 1956. it could also be issued to the directors or employees of the foreign subsidiary of an Indian incorporated company a foreign subsidiary is incorporated outside India and can at best be covered by the definition of ‘body corporate’ and not a ‘company’ under the Companies Act, 1956, the section has made a fiction of including such a body corporate as a company for the purposes of issue of sweat equity shares. While the section mentions only ‘employees or directors’ the SEBI regulations also mentions issue of sweat equity to ‘promoters’. The Consideration for Issue of Sweat Equity The allotment of sweat equity should be ‘at a discount’ or ‘consideration otherwise than cash’. Sweat equity could be issued in consideration of providing know-how or making available rights in the nature of intellectual property or for value addition contributed by such employee or director.


THE PRICE AT WHICH THE SWEAT EQUITY COULD BE OFFERED The SEBI regulations state that the price shall not be less than the higher of the following- The average of the weekly high and low of the closing prices of the related equity shares during last six months preceding the relevant date; or The average of the weekly high and low f the closing prices of the related equity shares during the two weeks preceding the relevant date. The regulations for unlisted companies provide that the price should be “fair price calculated by an independent valuer” and separate consideration is given for issue of sweat equity in case of ‘consideration other than cash’ CLASS OF SHARES WHICH COULD BE ISSUED AS SWEAT EQUITY Sweat equity shares can issued only of a class of shares already issued it must be only an ‘equity’ shares and not a ‘preference share’.


ISSUING OF SWEAT EQUITY SHARES GENERAL PRINCIPLES IN ISSUE OF SWEAT EQUITY The issue shall be authorized by a special resolution. The issue of sweat equity shares by a listed company shall be in accordance with the SEBI (Issue of Sweat Equity shares) Regulations, 2002. In case of an unlisted company, issue of sweat equity shares shall be subject to Unlisted Companies (Issue of Sweat Equity shares) Rules, 2003. Sweat equity shares is treated as any ordinary equity shares issued by the company in all respects except in certain cases the issue is for consideration other than cash. The voting rights and rights as to dividend etc. will be pari pasu with the existing class of equity shares. In terms f section 77A (5) (d) it is possible for the company to buy back sweat equity issued to employees of the company pursuant, inter alia, to a scheme of sweat equity.


SWEATY EQUITY SHARES AND UNLISTED COMPANIES Under The Proviso To Clause (D) To Sub-section (1) Of Section 79A, It Is Provided That In The Case Of A Company Whose Equity Shares Are Not Listed On Any Recognized Stock Exchange, The Sweat Equity Shares Should Be Issued In Accordance With The Guidelines As May Be Prescribed. Unlisted Companies (Issue Of Sweat Equity Shares) Rules, 2003 Have Been Introduced To Whom Sweat Equity Could Be Issued Price At Which Sweat Equity Could Be Issued Authorisation By Special Resolution Restriction on Issue of Sweat Equity Shares for more than 15% of total paid up equity share capital in a year or shares of the value of 5 crores of rupees, Register of Shares Lock-in of Sweat Equity Shares Certificate from Auditors


SWEAT EQUITY SHARES AND LISTED COMPANY 79A (1)(d), sweat equity shares in cases of companies listed on a recognized stock exchange must be in accordance with the regulations made by the SEBI. SEBI has issued the SEBI (Issue of Sweat Equity Shares) Regulations, 2002, laying down the guidelines for the issue of sweat equity shares by listed companies. Applicability To Whom Sweat Equity Could Be Issued Pricing of Sweat Equity Shares Valuation of Intellectual Property Authorisation By Special Resolution Promoters & Sweat Equity Shares It is not clear whether sweat equity could be issued to ‘promoters’ as defined in these Regulations, unless such promoter is also either an employee or a director. Promoters could also be shareholders. in case of issue of sweat equity to promoters both the requirement of special resolution (at which the promoter also could vote) as also an ordinary resolution (wherein the promoter do not participate) shall be passed. In addition the resolution could be passed by postal ballot. ISSUE OF SWEAT EQUITY SHARES TO PROMOTERS- SOME ISSUES


ADVANTAGES AND DISADVANTAGES OF SWEAT EQUITY Advantages of Sweat Equity Shares Highly efficacious in extracting the employees efficiency Promotional in nature as it a means of receiving shares without spending money Cost efficient for company as it can save on the employee’s to be given salary Receiving of sweat equity is a long term investment More income to the employees Receiving the right to participate in the company’s management for employees Disadvantages of Sweat Equity Shares More of dilution of power as share is being issued Can lead to inefficiency of employees when the feeling of being in power creeps in Can also lead to irregularity in income for the employees Consideration in the nature of share can be heavy on otherwise low income employees During recession or liquidation, the sweat equity share holders may face larger troubles as their effort go non-benefitted to them. Excessive issue of sweat equity shares can also lead to overcapitalisation which in turn would be heavy for the company


A COMPARATIVE STUDY OF ESOP AND SWEAT EQUITY ESOPS Types of ESOPS: Direct allotment of shares Option to acquire the shares Stock Appreciation Rights Issued when the company is well established It is issued as a motivation tactic. Can be issued only to directors & employees of the company Sweat Equity No options available for Sweat Equity holders Issued at the outset of a newly formed company or when the company is starting a new line of business It is issued to attract the best & most sought after people in the industry Can be issued to promoters, directors & employees

Conclusion : 

Conclusion Satyam Scam employees were holding 1.59 crore employee stock options (ESOPs). Each option can be exercised to obtain one share. The stock of the company lost more than three-fourth of its value in a single trading session. Sweat equity There is a long debate going on in relation of the issuance of sweat equity by the listed and unlisted companies, at present the issuance by type of companies are governed by different regulations, but it has been advised that to bring the uniformity in the law and to make it simpler for the companies, both of them should be governed by similar laws.

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