What are the shareholder rights given to the employee who exercises his ESOP?

ESOP shares are usually Equity shares which is different than preference shares that is given to Investors. Preference shares have additional rights like liquidation preference which is not given for equity shares. Equity shares have very basic rights e.g. receive annual report, attend AGM etc.

How is ESOP different from ESPP?

ESPP (Employee Stock Purchase Program) is typically used in public companies (traded on the stock exchange) which allows employees to buy company shares at a discounted price and is rarely used in startups.

What is ESOP and how is it granted to employee?

ESOP (Employee Stock Option Plan) is a great way of rewarding and retaining top talent for Startups. Note that these are Options and not shares. Options are granted through a letter of offer given by the company to its employee stating that he/she have the right to purchase 1000 shares of the company but it can be exercised (purchased) only after certain Vesting criteria is met. For example after completing one year with the company, he/she will be given the right to purchase 250 shares but the employee may choose to exercise (purchase) the shares much later (say after 5 years) when a new investor is willing to provide an exit (purchase his shares at a much higher price). If you need more details, consult your lawyer.

What is the tax impact for advisory equity?

In India, advisory equity where an advisor (or mentor) is given shares in lieu of him/her guiding or mentoring the Startup attracts GST. But the GST needs to be paid by the Advisor and not the Startup. If the Advisor is an individual, there are certain rules when he needs to file for GST. On the Startup side, you need to deduct the TDS though. For example, if shares worth 5 lakhs is given to an Advisor, the Startup needs to deposit 10% TDS i.e. 50 thousand rupees to IT dept immediately. Mostly this amount of 50 thousand is then reimbursed by the Advisor, so the Startup has no net cash outflow. For more details, consult your CA.

What is the typical grant you give to employees at various levels in a Startup?

This depends on the Startup stage and the importance of the employee. At the angel funding stage, it could be anywhere between 0.1% to 0.5% (even 1%) for core employees. Of course these percentages will go much lower for seriesA, seriesB+ funded Startups.

What is meant by Vesting (schedule)?

In a general parlance, the Options granted to the employee gives him/her the right to purchase the shares of the company subject to vesting. But this is attached with a schedule (called vesting schedule) only after which the right to exercise the options will arise. Vesting is the process by which an employee becomes eligible to exercise his/her stock options and become a shareholder in the Company. Vesting is dependent on the employee fulfilling certain service or performance conditions. For example, after one year 25% of options can be exercised and after that every 6 months 12.5% can be exercised over the remaining 3 years. This is called the vesting schedule, 4-year semi-annual vesting with 1-year cliff.

What happens to the ESOP when an employee leaves the company?

Typically, his/her unvested options will lapse. But he/she can exercise the vested options immediately or within a certain period of time as specified in the scheme document.

What is the typical size of ESOP pool in a Startup?

This can vary but in early stage startups, there could be 10-12% of the total shares kept aside for the ESOP pool. Note that this needs to be clearly specified in the SHA (shareholding agreement) and adopted by the shareholders approving the ESOP scheme document.

How can I share the captable with a prospective investor?

While you can share this over an email, it is better to share the captable only through mystartupequity.com as each access by investor is logged and he can’t download data unless you give this permission.

India has a 200 limit for the number of shareholders in a private company, does employee exercised shares also count towards this 200 limit?

No, the ESOP shareholders don’t count towards the 200 investors limit on the captable as per Indian laws.

Do you have to put an exercise price when granting ESOP to employees?

Yes, but the exact exercise price can vary from company to company and from employee to employee. Some companies may choose to keep the exercise price as the face value of the share. Some other companies may choose to keep the exercise price as a discount to the last round of funding - e.g. if the share price in the last round was 200 Rs, the exercise price may be kept as 30% discount i.e. 140 Rs per option.

What are the compliance related filing required for ESOP?

Firstly, the company needs to approve the ESOP scheme through a board resolution and then through an ordinary resolution passed by shareholders in AGM/EGM. This needs to be kept for internal purposes only, no need to file with the RoC. Your company secretary can take care of this. Second filing is required every year along with the Audit report. There is a table in the audit report that needs to show the number of options granted to every employee, options vested, options exercised etc. The P&L statement of the company also needs to factor the value of options given to the employees based on the option valuation report. Your CA and auditor needs to take care of this requirement. Third filing is required every time when an employee exercises his/her vested options. He needs to be given share certificates and the corresponding PAS-3 form needs to be filed with RoC. Again, your company secretary can take care of this. For more details, consult your lawyer, CA, CS, Auditor.

What are the typical errors in captable calculation?

Startups need to ensure calculation is done properly for captable. Sometimes there may be rounding off errors in terms of no of shares allotted to investors, class of shares allotted, ESOP pool not factored in, the total not coming to be 100% etc.

What is the process for secondary transaction for ESOP?

Doing a secondary transaction for ESOP is complex - price discovery, finding buyers, ROFR waivers, board resolutions, SPA (share purchase agreement), valuation report, RoC filings are among some of the things that needs to be taken care of. LetsVenture secondary platform takes care of all these problems and gives you a smooth experience.

What is ESOP scheme and how is ESOP rolled out in the company?

First and foremost you need to work with a lawyer to create an ESOP scheme document. This scheme document clearly defines how the scheme is going to be administered in your company. Typically this is done by founder-Directors in an early-stage startup. The scheme document also defined the regular exercise period (e.g. 10 years), what happens when an employee leaves (he may be asked to exercise within a shorter period), what happens when an employee is terminated (for a cause), default vesting schedule (1 year cliff, quarterly vesting for 4 years) etc. Once the scheme document is finalized (by the lawyer and founders), it needs to be approved by a shareholders’ resolution. Now you are ready to grant ESOP to employees. If you need more details, consult your lawyer.

What is the typical cliff period and vesting curve in a Startup?

Cliff period is the minimum time an employee needs to work in a company before any of the options can be vested. A minimum of 1 year cliff is required as per Indian laws and this is also the typical number Companies use for the Cliff period.

How do I allow for an employee to sell his vested ESOPs to a secondary buyer?

This usually needs board approval and ROFR waiver letters from existing investors (if there such a clause in SHA). Only then the employee can sell his vested options to a secondary buyer. LetsVenture secondary platform works with companies to exclusively take such ESOP secondary mandates and allow only company approved buyers to come in thereby making the process very founder-friendly.

Who is eligible for ESOP?

Typically only permanent employees and Directors (other than Directors who together with relatives hold more than 10%) in the company are eligible to receive ESOP. The eligibility criteria must be clearly documented in the ESOP scheme document as per Indian laws.

What is the tax impact when an employee exercises his ESOP?

As per Indian laws, the employee needs to pay income tax when he/she exercises ESOPs. The tax is calculated on the assumed income of FMV (fair market value) of shares on the exercise date - exercise price of shares. This tax should be deducted by the Company and remitted to the government as per TDS provisions. The FMV is determined using a valuation report provided by a CA (chartered Accountant). For more details, consult your CA.

Do you give Advisory equity (to Advisors) from the ESOP pool?

No, the advisory equity can’t be taken from the ESOP pool. ESOP is only for permanent employees of the company. Advisory shares should be given directly and filed in PAS-3 form with RoC. For more details, consult your lawyer.

DISCLAIMER

These FAQs have been prepared for general guidance on the subject matter and does not constitute professional advice. The matters described herein are general in nature and have not been evaluated based on applicable laws. You should not act upon the information contained in this note without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this note, and, to the extent permitted by law, LetsVenture Technologies Private Limited, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of LetsVenture Technologies Private Limited, this note may not be quoted in whole or in part or otherwise referred to any person or in any documents.