ESOPs can be an important tool to keep the company headed in the right direction under the leadership of its founders who became executive directors.
As new-age companies seek access to venture capital, private equity capital and then transition to larger listed companies, the founders’ shareholding in the company will get significantly reduced. The issuance of employee stock ownership plans (ESOPs) to founder-promoters who have now transitioned to single-digit shareholdings should not be separately regulated, as current regulations sufficiently empower the board and shareholders to approve such issuances. ESOPs can be an important tool to keep the company headed in the right direction under the leadership of its founders who became executive directors. SEBI should not have differentiated regulations for new-age companies, and ESOPs should be allowed to be granted to promoters of late-stage promoter-led or promoter-less companies.
The SEBI Issue of Capital and Disclosure Requirements (ICDR) Regulations define a ‘promoter’ as a person who has been named as such in the offer document or in the annual return of the issuer or a person who has control over the issuer (directly or indirectly) or on whose advice, directions or instructions the board of directors of the issuer is accustomed to act. Thus, the definition of promoter is wide-ranging and goes beyond persons in control of company (issuer).
The Companies Act, 2013 prohibits the grant of ESOPs to promoters as they are explicitly excluded from the definition of an 'employee'. This restriction is enumerated under Rule 12 (i) explanation of the Companies (Share Capital and Debentures) Rules, 2014 (Share Capital Rules) (relevant extract reproduced below):
“an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company but does not include-
(i) an employee who is a promoter or a person belonging to the promoter group; or
(ii) a director who either himself or through his relative or through anybody corporate, directly, or indirectly, holds more than ten percent of the outstanding equity shares of the company."
The said prohibition is not applicable to startups registered with the Department for Promotion of Industry and Internal Trade (DPIIT). In its February 2016 report, the Companies Law Committee recommended the issuance of ESOPs to promoters who may be working as employees or employee directors or whole-time directors, which would help the promoters to gain from increase in future valuation of the company without in any way impacting cash of the company during its initial years. The committee recommended certain changes to the Companies Act that included: (a) allowing start-ups to raise deposits for their initial five years without any upper limits, and (b) allowing startups to issue ESOPs to promoters working as employees.
Win-win for shareholders, company
For listed companies, any ESOPs issued to whole-time directors (WTDs) can be a win-win for all shareholders. This is because WTD can draw less cash compensation as salary in the initial years and be given ESOPs instead. Further, issue of share incentives prevents founders, who were the initial vision for the company, from losing interest in scaling up the business following their equity dilution after raising capital from private equity investors and public market investors. Also, it will help attract talent who are given ESOPs and thereby ensuring future growth.
Other forms of compensation like sweat equity and performance-linked plans are open for being allotted to WTDs, irrespective of them being promoters. However, they are not as attractive as the grant of ESOP.
Source: https://shorturl.at/ceFI1
