Employee Stock Option Plan (ESOP) is an employee benefit scheme under which the company encourages its employees to acquire ownership in the company in the form of shares by subscribing to it at a price that is lower than the market price. ESOPs are often used as corporate finance strategy without putting much burden on the cash flow of the entity, wherein it is believed that the employees who are also the shareholder in the company will focus better on the company’s performance and growth resulting in their share appreciation.
Thus, the company and the employee formulate a plan that gives the employees right to acquire a pre-defined number of shares in the company at the pre-agreed value within the stipulated period of time and hence the ESOP scheme is important to provide for the exhaustive details. In this content, we shall discuss the five clauses that should always form part of the ESOP scheme.
Five important clauses of ESOP scheme:
Now that you know how important it is to have an ESOP scheme, let us discuss below the five significant clauses of ESOP scheme.
- ESOP Pool and the eligibility criteria for the employees
This clause provides for the quantum of shares to be issued to the employees who fulfills the eligibility criteria as set out by the company.
Through ESOP Pool, the company specifies the maximum number and/or percentage of shares that can be issued to the employees of the company. It may provide for any modification in the ESOP Pool that can be made following certain procedure, such as, with approval of the board of directors of the company.
Eligibility criteria of the employees provide for the requirements under which an employee has the right but not an obligation to participate in ESOP scheme. The criteria may include:
- Number of years of service of the employee with the company;
- Position of the employee in the company;
- Performance of the employee with respect to achievement of the goals of the company;
- Future potentials of such employee;
- Grant and Vesting of Option
Granting of option clause list down the process through which price and date of issue of shares to the eligible employees under ESOP are identified.
The vesting clause lays down the time span when employee can exercise to shares options under ESOP. Thus this clause specifies the period of time during which options become available to the employee for exercise.
- Restriction on transfer of shares and lock-in period
This clause provides for the criteria for the transfer or sell of shares so allotted to the employee along with the necessary lock-in period, if any, within which the employees are restricted to transfer or sell.
The “Lock-in period” means the span of time during which transfers or sell by employees are restricted.
- Constitution of ESOP Committee
This clause says that the company shall forms a committee to look after the day-to-day operations of the plan so adopted by the company and the employee. This committee is responsible for taking every decision in regards to ESOP. Though this clause is not mandatory but from general parlance, it must be included in every plan setting out the roles and responsibilities of the Committee.
This clause is considered to be of importance as it lays down the provisions of taxability of ESOP at the time of exercise of option and allotment of the shares or when the shares are sold. It clause is important in the sense that it makes the company and the employee aware of the tax implications pursuant to ESOP plan.
ESOP is a great way to enhance and retain the employee in the company by benefiting both the company and the employee. However, one has to be very cautious in regard to ESOP compliance and its taxability so as to derive the most benefit out of it.
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