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ESOP- Way to reward and retain your employees.

We all have read about the acquisition of Indian retail giant Flipkart by US retail stalwart, Walmart for a whopping $16-billion. In that deal the employees of the Flipkart also struck a killing deal, when the Walmart decided to purchase of the shares of the employees of Flipkart by shelling out more than $800 Mn (Approximately Rs. 5670 Crore). That is the beauty of ESOP. In this article I am briefing about ESOP that can be implemented by Unlisted Companies.


In order to reduce the brain drain and to have a control over the employee attrition, many Companies are adopting novel and innovative practices. Compensating the employees by allotting them the shares of the company is the most prevalent practice among many companies to arrest the attrition rate and to boost the employee morale. By allotting the shares to employees an ownership feeling will be developed among them and it will help the companies to take them into confidence in many critical areas. Some employers use share-based payments as a part of remuneration package for their employees. Such payments generally take the forms of Employee Stock Option Plans (ESOPs), Employee Stock Purchase Plans (ESPPs) and stock appreciation rights. ESOPs are plans under which an enterprise grants options for a specified period to its employees to purchase its shares at a fixed or determinable price. ESPPs are plans under which the enterprise grants rights to its employees to purchase its shares at a stated price at the time of public issue or otherwise. Stock appreciation rights is a form of employee share-based payments whereby the employees become entitled to a future cash payment or shares based on the increase in the price of the shares from a specified level over a specified period. Apart from using share-based payments to compensate employees for their services, such payments are also used by an employer as an incentive to the employees to remain in its employment or to reward them for their efforts in improving its performance.

Employee Stock Option (ESOP) means a right of an employee to buy shares of a company at a price fixed on the date of the grant. At the same time it is not an obligation for an employee to purchase the shares granted to him.

ESOP works as a motivational tool to the employees and it can form part of the compensation package. It is an effective mechanism to attract and retain talented employees to an organization. It will enable the employees to create wealth by participating in the growth of the company.

An unlisted company can allot shares to its employees under a scheme of employees’ stock option (hereinafter referred to as "Employees Stock Option Scheme") subject to certain conditions.

Rationale behind ESOP.

As mentioned above, ESOP is the right given to the employee to purchase the shares of the company at a predetermined price on meeting certain conditions attached thereto. That means options can be converted into shares by the employees on meeting certain criteria. This criterion is called “Vesting Conditions or Vesting Criteria”. Vesting Criteria can be either continuation in the employment for a certain period or satisfaction of certain goals by the option holder. On attaining the said criteria, the options are said to be vested in the name of the option holder. There shall be a minimum period of one year between the grant of options and vesting of option.

ESOP- How it works

Once the option is vested as above, it gives the option holder an unfettered right to exercise the same and the shares shall be allotted to the employee. But if the employee is terminated for misconduct, then even his vested options may lapse. Exercise of an option is the process by which a vested option is converted into shares by payment of the exercise price. The exercise price is normally determined at the time the option is granted to the employee. In a case where options are granted by a company under its Employees Stock Option Scheme in lieu of options held by the same person under an Employees Stock Option Scheme in another company, which has merged or amalgamated with the first mentioned company, the period during which the options granted by the merging or amalgamating company were held by him shall be adjusted against the minimum vesting period.

Regulatory aspects pertaining to issuance of ESOPs

The provisions of law applicable for an ESOP issuance are listed below:

  1. Companies Act, 2013 and the allied rules

  2. Foreign Exchange Management Act (FEMA), 1999

  3. Income Tax Act, 1961

  4. Department of Public Enterprise (DPE) Guidelines (additional Guidelines for PSUs only)

  5. SEBI (Share Based Employee Benefit) Regulations, 2014 (In case of listed entities only)

  6. ICDR Regulations, 2009 (in case of listed companies only)

Type of Employee Share Based Payments [ESBP].

Some of the ESBPs have been explained briefly below:

  1. Employee Stock Option Plans (ESOPs) . ESOP is a contract that gives employees the right, but not obligation, to purchase or subscribe to a specified number of shares of the company at a fixed price, that is, the exercise price. The exercise price remains fixed even if the market price goes up in future.

  2. Employee Stock Purchase Plans (ESPPs) ESPP is a plan under which the company offers shares to its employees at a discounted price as part of public issue or otherwise.

  3. Stock Appreciation Rights (SARs) SARS are rights that entitle the employees to receive cash or shares for an amount equivalent to the excess of market price on exercise date over a stated price.

ESOP Structures.

There are two prevalence modes for implementation of ESOP. They are (1) Direct Route (2) Trust Route.

  1. Direct Route. In Direct route, the company grants the options to the employees and at the time of exercise fresh shares are being allotted to them, resulting to which the employee will become the shareholder of the company. Most of the unlisted companies prefers Direct route. The major issue in following that route is the availability of the limited options to the employees to monetize their investments. They have to either wait for a buy back or IPO to get an exit from the company.

  2. Trust Route. In this route a separate trust shall be registered, independent of the promoters and management of the company to acquire either through new issue or through the acquisition of shares from the secondary market. The company has an option to provide loan to the trust to enable it to acquire the funds from the secondary market. Section 67 of Companies Act, 2013 read with Rule 16 of the Companies (Share Capital and Debentures) Rules, 2014 allows the unlisted public companies to make provisions of money involving purchase or subscription of its own shares or shares of the company subject to compliance of certain conditions. This route is mainly followed by listed companies, which can purchase the shares from the secondary market.

Provision of Money by Company for Purchase of its Own Shares by Employees or by Trustees for the Benefit of Employees

The company can create provision of money for the purchase of , or subscription for, shares in the company or its holding company, if the purchase of, or the subscription for, the shares by trustees is for the shares to be held by or for the benefit of the employees of the company subject to the following

  1. the scheme of provision of money for purchase of or subscription for the shares as aforesaid is approved by the members by passing special resolution in a general meeting;

  2. such purchase of shares shall be made only through a recognized stock exchange in case the shares of the company are listed and not by way of private offers or arrangements;

  3. where shares of a company are not listed on a recognized stock exchange, the valuation at which shares are to be purchased shall be made by a registered valuer;

  4. the value of shares to be purchased or subscribed in the aggregate together with the money provided by the company shall not exceed five per cent. of the aggregate of paid up capital and free reserves of the company;