Back to Basics. ESOPs as a tool to retain talent

Employee stock ownership plans (ESOPs) are considered an attractive incentive for employees by companies in India and abroad.

Traditionally, ESOPs were offered to reward performance and/or to retain top management employees by motivating them through ownership. In recent years, with the increase in the number of start-ups, ESOPs have become more broad-based to attract/retain talent.

Attracting employees

ESOPs enable start-ups to attract and retain top talent without having to pay high cash salary in the initial years. Such ESOPs create a sense of ownership among the employees.

While the employees may receive lower cash salaries on account of the ESOPs being offered, increased company valuations could result in superior monetary gains in the future.

ESOPs are also popular in sectors such as financial services and manufacturing.

In such companies, ESOPs are generally offered to select employees to reward performance and retain them. Recognising the popularity of ESOPs, the Finance Ministry has agreed in-principle to allow public sector banks to offer ESOPs to their employees.

Apart from traditional ESOPs, variants such as restricted stock units (RSUs) and phantom stocks are also gaining popularity. ESOPs that are tailor-made to suit organisational objectives prove to be powerful tools to inspire employees. Sufficient time needs to be set aside for pre-planning to align the interests of employees and that of the organisation before implementing ESOPs.

The various factors to arrive at the right ESOP to suit the organisation involve consideration of how much, how often and whom to grant to, lock-in period, exercise price, exercise period, exit mechanism, transparency, linkage with the performance management system, etc.

The regulators have also been active in recent years in ensuring that the plans are managed in a fair and transparent manner, protecting the interest of all stakeholders.

While ESOPs issued by listed companies are regulated by the SEBI (Share Based Employee Benefits) Regulations, 2014, those issued by unlisted companies are regulated by the provisions of the Companies Act, 2013, read with Companies (Share Capital and Debentures) Rules, 2014.

Foreign-exchange regulations permit Indian companies to issue ESOPs to employees who reside outside India and Indian employees to receive ESOPs offered by foreign companies, subject to conditions and compliance requirements. The tax laws also provide specific guidance on the taxability of ESOPs.

Implementation is key

ESOPs may sometimes be counter-productive if not designed carefully. This necessitates companies to review/revisit existing ESOPs to make them more relevant and attractive to employees.

A common mistake made by unlisted companies is not providing a robust exit mechanism which enables employees to monetise the shares they hold.

There is also an element of risk involved in ESOPs if the shares of the company do not perform as expected.

The writer is Tax Partner, People Advisory Services, EY India. Meena Narayanan, senior tax professional, EY, also contributed to the article.

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