EMPLOYEE STOCK OPTION PLAN - SCHEME, SHARES, HOW IT WORKS

Employee Stock Option Plan or Employee Stock Ownership Plan (ESOP) is a plan or scheme for the benefit of employees. It enables employees to own shares of the company where they are employed. These shares are purchased by employees at a lower price than the market price, or at a discounted price. Such plans are for the existing employees as rewards on the basis of tenure or on the basis of their performance.

Section 62(1)(b) of the Companies Act 2013 states that - Where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered— to employees under a scheme of employees’ stock option, subject to special resolution passed by company and subject to such conditions as may be prescribed. The prescribed conditions or prerequisites of ESOP are mentioned under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. 

The main purpose of providing ESOP is to make the employees more committed towards the company, and it also helps to retain employees. ESOP motivates the employees to take ownership of the company and be committed towards it for the long term and as well.

Employees are eligible for this scheme when they complete a specified period with the company, as mentioned in the scheme of ESOP scheme, to claim its benefits. This period is called the vesting period. After the completion of the vesting period, the employees become eligible to purchase the specified number of shares of the Company as discussed or mentioned, at a predetermined price. The duration of the vesting period may differ company to company as per their policy.

 How Does It Work

1. Setting Up the ESOP Trust

The company creates a trust, holding account where shares are stored until they're distributed to employees. The company can either:

• Create new shares and place them in the trust, or
• Use company funds (or borrowed funds) to buy back shares from existing owners.

This process doesn't dilute ownership randomly. It's a strategic move to build long-term value and loyalty.

2. Allocating Shares to Employees

Each year, a portion of the shares in the ESOP trust is allocated to employees. The way shares are distributed usually depends on salary levels or tenure. In most cases, the more years you work at the company, the more shares you’re eligible to receive. The employees don’t buy these shares but are rewarded as part of the plan.

3. Vesting: Earning Your Ownership

Vesting means that the employees get the ownership of the shares that have been allocated to them. Companies set a vesting schedule, after which the employees earn rights to the shares over time. If the employee leaves the company before the maturity of the vesting period, the employee forfeits any unvested shares.

4. Becoming a Shareholder

Once vested, the employee officially becomes an employee-owner. Employee owns part of the company and benefits if the value of the company grows. Some ESOPs also give voting rights (especially in private companies), though this varies on the basis of the plan.

You might also receive dividends, depending on how the company is structured and whether it chooses to share profits.

5. Cashing Out: What Happens When You Leave

When the employee leaves or retires, the company buys back the shares at their fair market value (which is determined by an independent valuation each year). This payout can come as:

• A lump sum
• Instalments over a period (especially for larger balances)

The cash becomes a part of the employee’s retirement funds or can be used however the employee chooses.

Can ESOP shares be waived off?

As Employee Stock Options (ESOPs) are an option, they can also be waived off. It depends on a number of factors, like the terms of the ESOP policy, employment status, vesting conditions, and mutual agreements between the employee and employer.

In the context of ESOPs, waiving off can refer to several actions:

• The employee voluntarily gives up the right to exercise their stock options.
• The company is cancelling or forfeiting unvested or vested options under specific conditions.
• A mutual agreement between both parties to nullify or terminate ESOP rights.

Each scenario has its own implications and legal requirements.

 Legal Grounds for Waiving ESOPs

1. Voluntary Waiver by the Employee

An employee may choose to waive or surrender their right to exercise stock options voluntarily. This is most common in the following situations:

• The employee is leaving the company and chooses not to exercise vested options.
• The employee believes the exercise price is too high relative to the company’s valuation.
• Tax implications make exercising the options undesirable.

In such cases, the employee usually needs to sign a formal waiver letter, acknowledging that they are relinquishing their rights to the granted ESOPs and confirming that this decision is made knowingly and without coercion. This waiver is often supported by a clause in the ESOP agreement that permits the employee to forfeit unexercised options voluntarily.

2. Forfeiture of Unvested Options

ESOP schemes generally include a forfeiture clause that allows the company to automatically cancel any unvested options if the employee leaves before completing the vesting period. This is not technically a waiver by the employee, but the result is the same: the employee loses the right to those shares.

Typical forfeiture triggers include:

• Voluntary resignation before full vesting
• Termination due to misconduct
• Breach of employment terms

Since unvested options are still under the control of the company, it reserves the right to revoke them as per the terms outlined in the ESOP scheme.

3. Non-Exercise of Vested Options Within Exercise Period

Even after options have vested, they don’t become actual shares unless the employee exercises them. Every ESOP scheme defines an exercise window, usually ranging from 30 to 180 days post-resignation or termination. If the employee doesn’t exercise within this window, the vested options lapse. This is an automatic time-based waiver.

This, too, is typically covered under the ESOP policy and does not require any additional documentation from the employee.

Mutual Termination or Modification of ESOPs

In some cases, both the employer and employee may come to a mutual agreement to waive ESOP rights, particularly in scenarios like:

• Role change or re-negotiated compensation packages
• Performance issues
• Restructuring of the company or closure of a business unit

In such cases, a Mutual Waiver Agreement may be executed, outlining:

• Which options are being waived
• Whether any compensation will be paid
• A release of future claims

This route is sensitive, and legal counsel is usually involved to ensure compliance with employment and securities laws.

When Waiving ESOPs Is Not Allowed

While many ESOPs include flexibility for forfeiture and waivers, there are boundaries. Some actions may be legally or ethically questionable, such as:

• Forcing an employee to waive ESOPs without consent
• Revoking already exercised shares or owned shares
• Discriminatory practices in waiving options

Companies must operate within the framework of:

• The Companies Act, 2013
• SEBI (Share Based Employee Benefits) Regulations, 2014 (for listed companies)
• Internal ESOP policy and board resolutions

Any unjustified waiver or forced cancellation could lead to legal action or employee grievances.

Strategic Reasons for Waiving Off ESOPs

There are also strategic reasons why either party might consider waiving stock options:

From the Employee’s Side:

• Avoiding tax burden on exercising
• No confidence in the company’s future value
• Join a competitor (where holding equity is not ideal)

From the Employer’s Side:

• Avoiding dilution when funding is tight
• Retiring old grants and offering revised ones
• Ensuring options don’t accumulate if they’re unlikely to be exercised

In these cases, a waiver (voluntary or mutual) may be a cleaner solution than letting options expire passively.

Why Do Companies Offer ESOPs?

ESOPs are a strategic tool with multiple benefits:

• Attract Top Talent: Startups and growth-stage companies often can’t match corporate salaries. ESOPs help bridge that gap by offering long-term value.
• Retain Key Employees: The vesting structure encourages employees to stay longer, reducing turnover.
• Boost Performance: Employees with ownership stakes often take greater initiative and responsibility, aligning personal success with company success.
• Preserve Cash Flow: ESOPs allow companies to reward staff without paying out large amounts in cash, which is critical for businesses in early growth stages.