What are SEBI ESOP Regulations?

The SEBI ESOP regulations were last revised in July 2021 and are more robust, keeping in line with the global practices in ease of doing business. Before we delve into the details of the changes, let’s first understand what ESOPs are and what SEBI ESOP guidelines are in general.

Let’s get to it.

What are ESOPs?

Employee Stock Ownership (Options) Plan, abbreviated as ESOPs, is a strategy employed by firms to encourage employee ownership in the company. This acts as a retention strategy to keep employees from leaving and working in the company for the long term. It is regulated by section 62(1)(b) of the Companies Act 2013 and SEBI(SBEB and Sweat Equity Regulations) guidelines, 2021. It gives the employees the right to purchase or subscribe to the shares of the company at a given date at a given price decided in advance. ESOPs can be issued to:

• Permanent employees working in India or abroad.
• Director of the company, whole-time or part-time but not independent directors.

Allotting the ESOPs

There are three main terminologies you need to be aware of when ESOPs are being given to employees:

• Grant - This is the issuing of stock to employees. The employee is informed that they are eligible to receive the stock options. The company has the liberty to determine the price at which the stocks can be exercised when providing the stocks to the employees.
• Vest - This means that the employee has the right to apply for the shares granted to them. Normally, there is a minimum of one year time period between the grant and vest date before they are available to be vested.
• Exercise - The period where the employee decides to exercise the right to buy the shares. The company has the freedom to decide the lock-in period for the shares issued after exercising. The employees cannot enjoy the same benefits as a normal shareholder with respect to the ESOPs until the shares are issued on exercise of their option.

ESOP Regulation

As mentioned earlier, the ESOPs are regulated by the Companies Act 2013 and SEBI (SBEB and Sweat Equity Regulations) Guidelines, 2021.

To the uninitiated, the Companies Act 2013 is an Indian law regulating the incorporation, responsibilities, and dissolution of companies. It is divided into 29 chapters containing 470 sections (section 62 1b talking about ESOPs).

Sweat Equity and Share Based Employee Benefits (SBEB) fall under the Companies Act. Sweat Equity is non-monetary contributions that founders normally make toward the company. Businesses or start-ups that are cash-strapped use this to fund their companies. Sweat Equity shares are issued by the company to its directors or employees at a discount and will need to be eligible under the SBEB.

All the above rules and regulations are applicable to listed companies (listed on exchanges) as these have been framed by SEBI. For unlisted companies, any change will need to be brought into the Companies Act, 2013.

What are the latest changes made that have an impact on the ESOPs?

The regulations keep getting updated and amended from time to time to keep up with the advancement, in line with the global change in ease of doing business. Some of the major changes mentioned include.

1. Definition of the term employee

The meaning of the term “employee” is relevant in this case since it determines the eligibility and issue of ESOPs. Initially, as mentioned earlier in the blog, employees meant permanent employees, but now the word permanent has been amended, and employee has been expanded to:

• Removal of the word permanent
• Employees who are on probation or deputation are also included
• Employees hired on a contract basis or “gig workers” are included.

This has broadened the scope of employees, especially now since freelancing is also on the rise.

2. Grant Date and Vesting Period

The grant date and vesting period have been amended with regard to the instances.

• Grant Date - According to SBEB, the grant date is the date when the grant is approved. The proposal is looking at aligning the grant date with the applicable accounting standards.
• Vesting period - The rules for the vesting period in the case of death or permanent incapacity have been relaxed. Normally, there is a one-year time period between the grant date and vesting period, but in the case of death or permanent incapacity, the vesting period will be on the date the incident occurs.

3. Sweat Equity Shares

The following details need to be furnished when issuing sweat equity shares to the employees

• Objective
• Maximum limit on sweat equity shares that can be issued
• Lock-in period and pricing formula

4. Cessation of Employment

For any reasons like retirement, closure of business, lay-offs, etc., all the ESOPs, stock appreciation, quantity of stocks, and other benefits that are granted but not vested will expire. The new proposal states that cessation of employment due to retirement will not deprive the employee of the above benefits. This is, however, subject to applicable laws and policies laid out by the company.

5. Special Amendments

The minimum lock-in period for promoters has been slashed to 18 months from three years and to six months from one year for other investors. This allows easier exit for promoters and investors.

Wrapping up

ESOPs has become an attractive and effective way of retaining talent in the organization, which in turn is a win-win for both employees and the organization. Such plans have given importance to employees as they get to be directly responsible for the company to grow. And it is important the ESOPs are properly scrutinized and regulated before being handed over to employees. Regulations like these need to be constantly updated time and again to stay relevant and adapt to the changing scenarios in business to ensure smooth growth of the company and better arrangements for the employees.

Frequently Asked Questions

1. Which employees are not eligible for ESOPs?

ESOPs can be given to all employees except directors and promoters who own more than 10% equity in the company. Independent directors are also not eligible for ESOPs.

2. What is the difference between ESOPS and ESPS?

The difference between the two can be summarised in the table below

3. Do SEBI ESOP regulations apply to all companies?

These regulations apply to only listed companies, unlisted companies still come under Section 62(1)(b) of the Companies Act, 2013,

4. What are the rules for ESOPs?

The foundational rule for ESOPS is that while any business may issue ESOP, it must be issued in compliance with the requirements of the Companies Act of 2013 and the Companies (Share Capital and Debentures) Rules of 2014. This applies to all businesses other than those that are publicly listed (ESOP for private companies)

5.What are the key SEBI guidelines on employee stock option scheme?

ESOPs are regulated by section 62(1)(b) of the Companies Act 2013 and SEBI(SBEB and Sweat Equity Regulations) guidelines, 2021. It gives the employees the right to purchase or subscribe to the shares of the company at a given date at a given price decided in advance. ESOPs can be issued to:

• Permanent employees working in India or abroad.
• Director of the company, whole-time or part-time but not independent directors.