ESOP vs Phantom Stock - Track Changes

INTRODUCTION

As its name suggests, employee stock ownership plan is an extensive employee benefits offering that works as a meaningful way to drive employee satisfaction, motivation and retention.

Whereas the employee benefit plan such as medical, life and disability insurance plan, retirement benefits plan, paid-time-off benefits provide financial security to employees, Employee ownership Plan not only cultivate the feeling of financial and social security but also nurture the sense of responsibility and commitment towards the organization.

Why ESOPs?

ESOPs are one of the easiest ways to incentivize your workforce. Human resourcesare themost important assetsof an organization. The caliber and level of motivation of the people working therein plays a vital role in the growth of a Business Model. .

Basically ESOP are the fruits of efforts made by employees and an incentive for future business growth. ESOPs are found in publicly traded and closely held companies of every size, across every industry of the economy.

ESOPs- An Effective Compensation Tool

An Employer offers ESOP's to its employee on the basis of multiple factors.

The ESOP Scenario is very much adoptable in start-ups, which are not able to offer large compensation packages to its employees. Employee benefit plan is basically a corporate finance tool to:

1. Negotiate in CTC of existing and perspective employees and
2. Retain higher talent at lower price.

After granting the ESOP, an organization gets the employee indulged in the growth of a company. Hence motivating them to deliver their efforts with a feel of ownership interest in the company.

TheCompanies provide ESOP to employeesso that they can easily make long term commitment towards the company..

Various forms of employee ownership plan

Various forms of ownership plan includeEmployee stock purchase plan, stock options,Restrictive Stock Units, Stock Appreciation Rights andPhantom Stocks.

• Employee stock purchase planallows employees to purchase shares of the companies from their personal money (After tax salary)at a discounted price.
• Option planare basically rights given to employees, which entitled them to buy shares of the company in future.
• Restricted stockgives the employees the right to receive shares or equivalent cash compensation on a pre-determined date subject to occurrence of a specified event or fulfillment of specified conditions.
• SAR and Phantom stock, as sometimes used interchangeably,is basically in the form of bonus given to employees which is a appreciation in the share price of the company over a span of time... The SAR comes with great benefits that employee doesn't need to buy shares he can enjoy the fruits of rise in stock price without subscribing the shares.

The Companies Act, 2013 is the primary legislation in India governing both listed as well as unlisted companies. It deals with the scheme of employees'stock options, which essentially qualifies as an employees' benefit scheme, although not legally labeled so.

The Act further provides that for the purposes of increasing its subscribed capital, a company shall offer further shares to, inter alia, “Employees under a scheme of employees' stock option, subject to special resolution passed by company and such conditions as may be prescribed.”

The Act also provides the definition of “Employees” to determine the criteria of being eligible for ESOPs.

The term 'employee' means: a) a permanent employee of the company (irrespective of whether he has been working in India or outside India); b) a director of the company (irrespective of whether he is a whole time director or not, provided he is not an independent director); and c) an employee fulfilling the aforesaid criterion of a subsidiary, in India or outside India, or of a holding company of the company; but does not include:

“(a) an employee who is a promoter or a person belonging to the promoter group; or

(b) a director who either himself or through his relative or through anybody corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

Implementation of Scheme

Essentially, a company has two options through which it can implement the scheme, i.e. either by itself or by way of trust. However, In case of listed Company, it is obligatory on the part of the company to implement the scheme through trust, in case a secondary acquisition of shares, or gift, or both, is involved.

The schemes is initially formulated and approved by the Board of Directors of the company. Thereafter, these are approved by the shareholders by way of a special resolution (Ordinary resolution in case of Private Company) in the general meeting. For administration and implementation of the schemes, the company, if required, constitutes a Compensation Committee, which shall inter alia comprehensively delineate the terms and conditions of the schemes, as specified under above mentioned Act. The Compensation Committee will also determines the eligibility criteria of the employee for the purpose of entitling him to participate in the scheme

Procedure for issuance of ESOP under Companies Act, 2013

Once a company has identified employees who shall be eligible to avail the benefits under ESOP schemes, the company needs will carry out the following:

1. Prepare an ESOP Scheme

2. Approval of the Scheme by Nomination and Remuneration Committee (where a company has one)

3. Convene a board meeting to approve the scheme.

4. Convene the shareholders‟ meeting for approving the scheme.

a. The notice to the shareholders‟ meeting shall give out details with regard to the scheme. Some of these details are specified in Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 and include:

i. Total number of stock options to be granted;

ii. Identification of classes of employees who shall be eligible under the scheme

iii. Appraisal process for determining the eligibility of employees

iv. Details of vesting and vesting period

v. Determination of exercise price and the process of exercise

vi. Lock-in period

vii. Maximum number of options to be granted per eligible employee and in aggregate etc.

b. A separate shareholders‟ resolution is required where:

i. The option is granted to the employees of holding or subsidiary company.

ii. Grant of option to identified employees, during any one year, equal to or exceeding one percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option

5. File necessary forms with ROC.

6. Grant letter of option to eligible employees.

7. Once the option is accepted by the eligible employees, execute the ESOP agreement with each eligible employee.

8. On expiry of vesting period, where an employee has exercised the option to acquire shares, allot shares.

9. Once the scheme is afloat, the company shall in its Directors‟ Report for the year also specify the details of the ESOP scheme.

Maintenance of Register

The company shall maintain a Register of Employee Stock Options in Form no. SH.6 and shall forthwith enter therein the particulars of option granted. The Register shall be maintained at the registered office of the company or such other place as the board may decide. The entries in the register shall be authenticated by the compliance officer of the company or by any other person authorized by the Board for the purpose.

Taxability of ESOPs

(a)At the time of grant and vesting of options:No tax is payable at the time of grant and vesting of options as per current Indian tax laws.

(b) At the time of exercise of options:The excess of Fair Market Value (FMV) of the share on the date of exercise of option' over the 'exercise price' is treated as the perquisite value in the hands of the employee. The Company as per Income Tax law is required to deduct tax on the perquisite value treating it as a part of salary. Same rate of taxation shall apply as is applicable to salary.

(c) At the time of sale of shares:The tax is calculated on the excess of 'sales price' over the 'FMV of shares on the date of exercise'. The period for which the employee holds the shares till the day of sales would also be a determining factor of the amount of tax a employee would be required to pay on sale of such shares. (LTCG vs. STCG)

Employee Stock Option Scheme:

Employee Stock Option Schemes are the most commonly used form for employee ownership. . The principle message conveyed to the employees through ESOS is that, if they stay long enough till vesting, they stand to gain significantly through exercising the options. ESOPs are generally offered by offering fresh equity resulting in dilution of Promoters'stake and an alteration in the company equity structure.

• Employee Stock Option Plans/Equity Incentive Plans (commonly referred to as ESOPs) are one of the most important tools to attract, encourage and retain Employees. It is themechanismby which employees are compensated with increasing equity interests over time.
• Company grants an option to its Employee to acquire Equity Shares of the company at a future date and at predetermined price.
• There is no limit on quantum of ESOPs to be issued to employees

WHY ESOPS?

• Attract, Reward, Motivate and Retain Employees.
• Enhances job satisfaction
• Deferred compensation strategy
• Good retirement benefit plan
• Employee aligns with company's goals

MODES OF ESOP…

• Employee Stock Option Plans (ESOP).
• Employee Stock Purchase Plan (ESPP).
• Restricted Stock Units (RSU)
• Stock Appreciation Rights (SAR)/ Phantom Stock.

ESOP: It is a method by which company offer shares to its employees at a predetermined date on the pre-determined rate. Firstly company grant the option the employees and it has to be vested by employees for the specified period of time after that the option will be exercised and shares will be allotted by the company.

ESPP: Under this company just offer the shares to the employees at the discounted price. If the option has been exercised than company will allot the shares as per their ESPP plan.

Regulatory Framework in India

Issuance of ownership plan in India is covered under and governed by the following legislation:

1. The Companies Act, 2013
2. Companies (Share Capital and Debenture) Rules, 2014
3. Securities and Exchange Board of India (Share based Employee Benefits) Regulation, 2014, in case of Listed Company
4. Foreign Exchange Management Act (FEMA), 1999
5. The Income Tax Act, 1961
6. ICDR Regulations, 2009, in case of Listed Company

ACCOUNTING ASPECT

As per, Indian Acc Standard 102

• Employee Compensation Expense (equivalent to Price Discount)

Market Value- Price at which Shares are offered

For Company.

As such, the Company has no tax liability, it has just to book Compensation Cost in its Profit and loss account.

PHANTOM STOCK

Although, Phantom Stock's are not technically employee stock options, companies often use them in a like manner. Phantom Stock's provide employees with cash payments equal to the appreciation of the company's stock over a specified duration. Thus, unlike other options, Phantom Stock provides employees with equity upside without exposure to any downside.

ESOP vs. PHANTOM STOCK

A company can grant employee benefit related scheme to the eligible employees based on minimum period of services rendered, their performance, and on the basis of any pre-determined eligibility criteria.

What usually start-up do?

Mostly start-ups grant ESOPs to their employees to:

1. Negotiate in CTCs
2. Retain higher talent
3. Reward potential employees
4. Align employee's and company's goal

In the following ways:

Way 1: Company grants 'X' number of ESOPs at current market price to its employees, which will vest over a period of 1-4 year (mostly in equal proportion). Employees can exercise the vested options on happening of any liquidity event i.e. IPO, Strategic Sale, Merger/ Amalgamation etc. and realize the benefit of their holding. In this case employees have to wait for gains until happening of any liquidity event, which sometimes comes at a very later stage.

Way 2: Company grants X number of ESOPs at current price to its employees, which will vest over a period of 1-4 year (mostly in equal proportion). Employees can exercise the vested options within say 2 years from the date of respective vesting and realize their benefits upfront.

Way 3: Company grants X number of ESOPs at current price to its employees, which will vest over a period of 1-4 year (mostly in equal proportion). Employees can exercise the vested options on happening of any liquidity event i.e. IPO, Strategic Sale, Merger/ Amalgamation etc. and if no liquidity event happened with a specific period of time from the expiry of vesting period, the vested options will be exercised by the employees within the period as management decides.

Note: As per the Companies Act, 2013, there must be a gap of 1 year from the date of grant and vesting of option.