A Guide to Implementing ESOPs in Your Startup
As a startup founder, you start offering Employee Stock Option Plan (ESOP) to your important hires from day one. But, many founders have little idea how to formally start running ESOPs in the company. So, let me walk you through all the steps required if your Startup is registered in India. For Startups incorporated in other countries, the steps are mostly the same with some minor variations.
- The first step is to get an ESOP scheme prepared through a lawyer. This scheme document covers various legal clauses governing ESOP administration, pool size, grants, vesting, employee cessation, exercise period, etc. If you have raised any round of funding, it is most likely that the SHA from the round already has a provision for an ESOP pool, and the size of the pool is also quantified in the SHA. The lawyer will ask you several questions to add/modify clauses in the ESOP scheme document as per your requirements. Note that it is imperative to make sure that the scheme is drafted fairly and beneficially to the employees; otherwise, the whole purpose of ESOP as a tool to attract and retain talent may be lost.
- The next step is to get the board’s approval for adopting this ESOP scheme.
- The ESOP scheme must also be approved through a special resolution at the shareholders’ meeting (EGM). So you need to send an EGM notice for the same and then conduct the EGM and pass the shareholder resolution. Note that this needs to be a special resolution (votes in favor of the resolution at least three times than votes against) compared to an ordinary resolution (simple majority).
- The board and EGM resolutions must be filed with the Registrar of Companies (RoC) website using form MGT14. Your company secretary can do this. There is no other filing required with the RoC.
- Note that ESOPs are only options and not shares; therefore, there is NO need to increase the company’s authorized share capital at the time of ESOP grants. It only needs to be done when an employee goes for exercise, which is usually much later.
- Now, you are ready to formally grant ESOPs to your employees through a grant letter.
Note: We often come across founders trying to issue a grant letter to the employees backdated to an earlier date because the employee was promised these long before the ESOP scheme got approved by shareholders. This is not legal; the grant date must be greater than the ESOP shareholder resolution date. Do keep this in mind!
Reference: SEBI guidelines on ESOP
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