Information to Include in Director’s Report

The following information must be mandatorily disclosed in the Director’s Report filed by the Board of Directors:

1 Dividend, if declared & amount, if any, carried forwarded to reserves
2 Details of ESOPs:

a. Options granted

b. Options vested

c. Options exercised, and

d. Total number of Options in force, if any

3 Information about the financial performance / financial position and details of the subsidiaries / associates/ JV
4 Details of loans, investments and guarantees by the company
5 Details relating to deposits, covering the following:

Accepted during the year;
Remained unpaid or unclaimed as at the end of the year;
Whether there has been any default in repayment of deposits or payment of interest thereon during the year and if so, number of such cases and the total amount involved (i) at the beginning of the year (ii) maximum during the year and (iii) at the end of the year.
Details of deposits which are not in compliance with the requirements of Chapter V of the Act

6 Website address
7 Disclosures under the Sexual Harassment of Women at Workplace (Prevention, Prohibition & Redressal) Act, 2013
8 Borrowing by the company
9 Details of rent paid
10 Electricity expenses
11 Director remuneration (for each director)
12 Details of transfer of shares during the financia year
13 Break up of related party transaction (1. Name of related party and nature of relationship and 2. Duration of the agreement)

LexGyaan Series on ESOPs – Part 1: How do Employee Stock Options Plan (ESOPs) work?

CREATING AN ESOP POLICY

In our experience of having assisted several entrepreneurs with execution of ESOPs for their startups, we have observed that most entrepreneurs are under the impression that by just mentioning the number of ESOPs on their cap table, or in offer letters to their employees, the startup has fulfilled its obligation to grant ESOPs to its employees. This is actually incorrect.

Mentioning ESOP pool on your cap table actually just makes your investors happy. Why? Well when an investor invests in your startup, they want to ensure that they do not get diluted for any reason except in case of future rounds of fundraising by your startup (even for that they have the right to maintain valuation aka pre-emptive right). It is important for investors that their shareholding does not get diluted in order to give shares to your employees, mentors or all those well-wishers of yours, whose help and guidance you took in the initial days of starting up and promised equity to. Only you the founder should get diluted to give these promised equity shares to your mentors and advisors, not the investors. This is the reason why investors require a startup to create an ESOP pool/advisory stock option pool, as a condition precedent to their investment in a startup. This is also the reason why investors require you to convert all loans from friends and family, and conversion of convertible notes, if any.

Related reading: Understand how valuations work and how a founder’s shareholding gets diluted when an investor invests in a startup in our blog titled ” The Valuation Game.. What Does It Mean Exactly? , by our co-founder, Karthik Chandrasekar.  

Therefore, all you have achieved by mentioning a “ESOP Pool” on your cap table and inserting a number against it is (a) carving out the maximum number / percentage up to which your investors won’t get diluted, and (b) demonstrating to your investors, your intention to give ESOPs some day to your employees.

At this stage, where your startup’s ESOPs are only on the cap table, your ESOPs are only a virtual pool. How do you convert the ESOPs in to reality? Well, that’s easy, you will just have to create an actual ESOP pool. In order to do that, you will have to take the following steps:

Step 1

Draft an ESOP Policy in compliance with the Indian Companies Act, 2013. The ESOP Policy will have to set out in detail the terms of ESOPs, cliff period, vesting schedule, exercise price/strike price, exercise period, consequences of employee leaving the startup, consequences of the startup getting acquired, etc.

Sign up here to request a free Demo

Step 2

Once the draft ESOP policy has been finalized and if you have investors in your startup, then check your Shareholders’ Agreement and Articles of Association, to verify if the approval of investors for a ESOP policy will be required. Lost? Well, just look for a clause that is titled either as “reserved matter right” or “affirmative voting matter” or  “affirmative voting right” or “investor protection matter”. Once you find this clause, then look through the several items and check if creating a stock option, ESOP etc is listed therein. If it is, then you would have to send an email to your investor alongwith copy of the ESOP policy for your startup, requesting the investor for its approval to the ESOP policy.

LexGyaan: Most VCs get their respective legal team to also review the ESOP policy. Therefore, be prepared for few iterations and discussions.

 Step 3

Where you don’t have any investors in your startup, you can skip step 2 and directly proceed with step 3, i.e., convene a Board Meeting for approval of the ESOP Policy. How to convene a board meeting properly under Companies Act, 2013?

Step 4

Convene a meeting of Shareholders (aka EGM) of your startup, for approval of the ESOP Policy.

Now you have an ESOP policy and can formally start granting ESOPs. Click here to download a free template of a ESOP grant letter!

Click here to read FAQs on ESOPs.

LexStart makes ESOP creation a breeze. Click here to learn more. Request a Demo.

 

LexStart’s LexGyaan Series: Can I grant ESOPs to a Co-Founder?

Granting ESOPs to Promoters/Co-Founders

I often get asked this question – “Can I grant ESOPs to a Co-Founder who I recently brought on board my Startup?”. Well the answer is both yes and no!

The Companies Act, 2013 prohibits grant of ESOPs to the Promoter of a company. The term “Promoter” does not necessarily refer to only a person who is named as a Promoter at the time of incorporation of the company. A Promoter is defined broadly and includes, the following:

  • Any person who has been named as such in a prospectus or is identified by the company in its annual return; or
  • Any person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
  • Any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act. Provided that such person is not someone who is acting merely in a professional capacity.

Therefore, typically a Co-Founder who you bring on board at a later stage, may not be a Promoter as stated in the Charter Documents (Memorandum and Articles of Association of your Startup) but still can be considered a “Promoter”, thus restricting him from receiving ESOPs in the company.

ESOPs to Promoters/Co-Founders of recognized Startups

The Companies Act, 2013 has made an exception to the above rule, by allowing Startups that are recognized by Govt. of India to grant ESOPs to founders, as long as the grant of such ESOPs is within 5 years from their incorporation. This means if your Startup has a Certificate of Recognition from DPIT, Govt. of India, then you can grant ESOPs to Promoters/Co-founders.

Related Readings : How to Get Startup India Registration

FAQs on ESOPs

 

Issue of Shares with Differential Voting Rights

What is Differential Voting Rights?

Shares with Differential Voting Rights (DVRs) means shares that give the holder differential rights as to voting (either more or less voting right) as against the Ordinary shareholders of the company.

Types of DVR    

  • Shares that have superior voting rights
  • Shares that have inferior voting rights

Eligibility/Condition for issue of shares with DVR*

  • AOA of the Company should authorize issue of DVR;
  • Consistent track record of distributable profits for the last three years;
  • No default in filing annual return for last 3 Financial Years;
  • No default in payment of declared dividend or repayment of deposit or loan borrowed;
  • the shares with differential rights shall not exceed twenty-six percent of the total post-issue paid up equity share capital;
  • No penalty by court or tribunal for any offense for the last 3 Financial Years; and
  • The shares issued with DVR cannot be changed later.

*This provisions shall not apply to private companies in case MOA and AOA of the company provide otherwise.

Procedure for issue of shares with differential voting rights

  • Check AOA of the Company;
  • Obtain valuation certificate from registered valuer;
  • Open a separate bank account;
  • The terms of issue of shares should be finalized;
  • Conduct board meeting for issue of shares with DVR;
  • In case issue of DVR affects the rights of existing class of shares then obtain consent from 3/4th of the shareholders of that class;
  • Filing form MGT-14 with ROC within 30 days of EGM;
  • Circulate offer letter along with the share application form to the investors;
  • Receive share application money along with the application form ;
  • Conduct board meeting for allotment of shares;
  • File form PAS-3 within 15 days of allotment of shares;
  • Pay stamp duty and issue share certificates; and
  • Make entry in register of members.

Difference between DVR shares and Ordinary Shares

DVR shares
  • Provide few or higher voting right to shareholders.
  • Rate of dividend is low or higher.
  • DVR shares are ideal for small shareholders or promoters.
  • Issued at a discount in comparison with ordinary shares.
Ordinary Shares
  • One share One Vote.
  • Rate of dividend is fixed for class of shareholders.
  • Ideal for large shareholders.
  • Issue at FMV.

Advantages of Issuing shares with DVR

From Issuer Perspective
  • To raise more capital without diluting its ownership structure.
  • Get control in decision making process.
  • A tool to avoid hostile take over.
  • To fund large Project.
From Investor Perspective
  • Benefit to investors since share are issued at discount & also for incremental dividend.
  • Better for investors who are looking for good quick return rather than voting rights.
  • Institutional Investors can invest in private companies without any limit and making it a subsidiary.

Dis-advantages of DVR

From companies Perspective
  • Lack of investor awareness about such issue of shares.
  • Issue shares at discount.
  • Minority shareholders can lose faith in the Company.
From investor Perspective
  • Lack of investor awareness about such issue of shares.
  • Possible misuse of voting power
  • by the promoters & hence act
  • against the interest of the shareholders.
  • Lack of liquidity may hamper return.
  • Not beneficial for Institutional
  • Investors as they are
  • interested in voting rights and long term capital gains both.

Case of Tata Motors

  • In 2008, issued DVR shares.
  • It was the first company in India to issue DVR shares and amongst the very few in Asia.
  • Issued at Rs 305 a share which was about 10% lower than the issue of normal rights at Rs.340.
  • Will offer 5% of more dividends.
  • Gives an additional 10.3% discount.
  • But carry one-tenth the voting rights of ordinary shares. This means 10 DVR shares = 1 ordinary share as far as voting rights is concerned.

Amazon caps voting rights in Witzig Advisory Services at 17%

  • Amazon has bought 17% stake in the company through Class A shares and the rest 32% through Class B shares having differential voting rights (DVR).
  • Each Class A share shall have one vote, while the Class B shares shall not carry any voting rights. This effectively caps Amazon’s voting rights in Witzig at 17%.
  • Amazon appears to have made use of DVR shares to comply with the new ecommerce FDI norms that came into force from February 1, and also to ensure that More can continue selling on its Indian marketplace.
  • The new ecommerce FDI guidelines had forced Amazon to reduce its stake from 49% to 24% in Cloudtail and Appario, the two top sellers on its marketplace. The American etailer had also evaluated the idea of limiting its holding in Witzig to less than 26%, and not acquiring 49% in the company as was originally planned.
  • By capping its voting rights in Witzig at less than 17%, Amazon will be able to continue with More as a seller. Samara Capital will hold 51% in Witzig, making the latter an Indian owned-and-controlled company.

Conclusion

  • For an investor, who wants to be in the company’s decision processes, DVR  shares is not an attractive proposition due to limited voting rights.
  • But if an investor isn’t concerned much with voting rights, then investing in the DVR would certainly be an attractive option.

LexStart’s LexGyaan Series : Thinking of issuing ESOPs? 2 Things you need to know!

1. If it’s not to an employee or a director, then don’t call them ESOPs! Think of alternative structures.

ESOPs under Indian Companies Act, 2013 can be issued only to employees and directors. In case of a startup recognized by Department of Promotion for Industry and Internal Trade, you can even issue ESOPs to a promoter. Yes, you heard that right, ESOPs cannot be issued to promoters otherwise. Therefore, if you have promised ESOPs or sweat equity to a mentor or advisor or co-founder, think through and decide on alternative structures, unless you can actually issue ESOPs to them, under the law.

Related readings : Are you a recognized startup?

Do you qualify to be a startup?

2. There is a statutorily mandated 1 year cliff on ESOPs

The Indian Companies Act, 2013 mandates a 1 year cliff period. This is compulsory and you cannot contractually exempt it.

Related ReadingsMandatory 1 year cliff on ESOPs

Is your ESOP grant just an offer?

What should be the exercise price/strike price of an Employee Stock Option?

The exercise price for a stock option will depend on the objective for which the ESOPs are being granted. ESOPs for employees can be granted based on different considerations by different companies. In fact, even with respect to different employees within the same company, the exercise price may be different, as the ESOPs may be granted to the different employees by the company with different objectives in mind. Let us elaborate on how it works.

Remuneration lower than the market level

If you are granting ESOP benefits to your employees in lieu of salary, with the objective of making up for the lost compensation for an employee who has taken a huge salary cut and joined a start-up, it is only fair that the ESOPs be granted to the employee at an exercise price which is as low as possible. Typically, that would be the par value (or the face value) of the shares. The typical face value is INR 10, though, it differs from company to company. It would be advisable to check the face value of your company’s equity shares before finalizing the exercise price.

Market level remuneration

If your employees are already drawing market level salaries and the stock options are granted to them in the form of added incentive or bonus, then the exercise price of the options should be higher.

For example, if you are granting ESOPs soon after a fundraising round, then you could use the valuation of shares assigned by the investors in such round as the benchmark. So, if you have issued shares at a price of INR 100 per share to the investors, you could fix the exercise price at INR 100 per share or maybe at a discount to the fair market value, for instance, INR 80 per share.

I often get asked, if INR 100 (i.e. issuing shares at the fair market value) to the employees would be an unfair exercise price. I honestly don’t think so, simply because the employee is not going to buy the shares immediately. The employee can only buy the shares depending on the vesting date as per the vesting schedule, which will be after a minimum period of 1 year in India (given the mandatory 1 year cliff period). By that time, hopefully the fair market value of the shares of your company would increase. Therefore, at the time of exercise date, the ESOP still benefits the employee as the exercise price would be a discount to the then fair market value of the shares of your startup.

Are ESOPs free?

Are ESOPs free?

Yes and No.

The full form of ESOP is Employee Stock Options. Stock options are free and the options themselves are granted to the employees free of cost. They are considered as a part of an employee’s remuneration. It is a benefit given to the employee. There is no grant price to be paid for grant of ESOPs.

However, the definition of stock options is limited to only an option to purchase shares in the company in the future. An ESOP does not automatically convert into shares in the company.

This means that when the ESOPs granted to an employee vest, the employee will have to buy shares in the company. This process of purchasing shares in the company is called “exercise” of ESOPs. When an employee exercises the right to buy the shares in the company, the employee will have to pay the “exercise price” (or the purchase price) for these shares. This exercise price is typically decided upfront at the time of granting the ESOPs and stated in the ESOP policy, ESOP Agreement or the Grant Letter.

Therefore, technically, Employee Stock Options, as widely understood, are not free.

 

Want to understand more about ESOPs? Sign up with LexStart here and get access to our tutorials and FAQs for free.

LexGyaan Startup Series

Series 1 – Co-Founders’ Agreement and other legalities when starting up

Have an idea? Thinking of Starting Up? Or just testing the waters? You might be reaching out to consultants, developers, manufacturers etc. to improve upon your idea. Have you ensured that your idea is protected and you are not losing ownership of your idea or your brand for that matter? Further, as your founding team comes together, it is important to put down expectations on contribution and ownership in a Co-Founder’s Agreement. You then need to decide what kind of entity you want to house your team in. Its also important you take certain precautions. What if the idea materializes into something big? You don’t want to regret not having your developer bound by obligations to hand over the cool product that you conceptualized! This workshop helps you navigate each of these crucial decisions.

This workshop will cover the key issues an entrepreneur needs to tackle at the very outset, including:

– Co-Founders’ Agreement

– NDAs

– Hiring a web developer

– Deciding on incorporating an entity for the business,

– When to quit your current job

– Protecting your idea and your brand through trademark

Coming up:
Series 2: Starting Up
Once you have decided to proceed with you startup idea? What next? Just setting up an entity is not enough. There is hiring to do, NDAs to be signed, IP to be protected, and so on. In this second workshop in the LexStart Startup series, we will be discussing:
– Legal Cheat Sheet – Basic compliances required under the law

– Startup India – How to register? What are the benefits?

–  Hiring: HR agreements, policies and processes,

– Terms of Service and Privacy Policy

– Protecting your intellectual property

Series 3: Legalities of Structuring Incentive Plan for Employees and Advisors

 

ESOPs, Advisor Equity, Mentor Stock, these are the terms you hear a lot these days. But do you understand how each one of these work?In our third workshop of the LexStart Startup Series, we will be discussing legalities of Structuring Incentive Plan for Employees, Advisors and Mentors, including:– What exactly do each of these terms mean – ESOP, Advisory Equity, Mentor Stock

– How do they work and answer questions like – Does the employee have to pay money? Can they get shares upfront? What happens if they leave the company?

– Most commonly used structures, mechanisms and terms

– Tax consequences

Series 4: Fundraising for your Startup
In the last and most important workshop of the LexStart series, we will be discussing the various nuances of the fundraising process, including:

– Overview of process of fundraise

– Structures for fundraise – Convertible Note, Loan, Equity, CCPS!

– Term sheet and the various terms of investment – how to effectively handle negotiations with investors

– Due diligence – what does it mean and what does the process entail

– Share purchase agreement, share subscription agreement, Shareholders’ agreement – understanding the various documents

– What all do you need to do to get money in bank!

What happens if an employee leaves the company before the shares have vested?

This depends on the ESOP policy of the company. The norm is for the unvested ESOPs to lapse upon cessation of employment. This means that the employee will not be able to exercise and avail ESOP benefits from those ESOPs any more.

However, in case an employee suffers a permanent incapacity while in employment, all the ESOPs granted to him as on the date of permanent incapacitation, shall vest in him on that day and in the event of the death of an employee while in employment, all the ESOPs granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

Below are the typical scenarios:

Company Friendly
Event Vested Unvested
Termination with Cause Lapse Lapse
Termination without Cause Exercise within the notice period Lapse
Resignation Exercise within the notice period Lapse
Death or Disability Exercise within 3 months of the event Exercise within 3 months of the event
Retirement Exercise on or before the last working day Lapse

 

Employee Friendly
Event Vested Unvested
Termination with Cause Exercise immediately Lapse
Termination without Cause Exercise immediately Lapse
Resignation Exercise immediately Lapse
Death or Disability Exercise within 6 months of the event Exercise within 6 months of the event
Retirement Exercise within 6 months of the event Exercise within 6 months of the event

What does Cause in the above scenario mean?

 If your employment agreement has a definition of cause, you could consider including that. If not, then we would recommend the following definition:

“Cause” shall include:

  • Wilful insubordination or disobedience, whether or not in combination with another, of any lawful and reasonable order of a superior.
  • Theft, fraud, misappropriation, embezzlement, moral turpitude or dishonesty in connection with the employer’s business or property.
  • Habitual absence without leave, overstaying the sanctioned leave without sufficient grounds, or proper and satisfactory explanation, or habitual late attendance.
  • Commission of any act subversive of discipline or good behavior on the premises of the Company, such as, drunkenness, riotous, disorderly or indecent behavior, gambling or taking or giving bribes or any illegal gratification whatsoever.
  • Disregard of the rules of the Company.
  • Disclosing to any unauthorized person any confidential information with respect to the Company and/or its business and/or its operation, including but not limited to trade secrets, intellectual property etc.
  • Commission or attempt to commit any cyber-crime.
  • Proven instance of sexual harassment.
  • Any other grounds that results in the Board of Directors of the Company to conclude that the act or omission by the concerned person may result in loss, damage or injury to the Company.

 

 

What happens if an employee leaves the company before the shares have vested?

This depends on the ESOP policy of the company. The norm is for the unvested ESOPs to lapse upon cessation of employment.

However, in case an employee suffers a permanent incapacity while in employment, all the ESOPs granted to him as on the date of permanent incapacitation, shall vest in him on that day and in the event of the death of an employee while in employment, all the ESOPs granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

Below are the typical scenarios:

Company Friendly
Event Vested Unvested
Termination with Cause Lapse Lapse
Termination without Cause Exercise within the notice period Lapse
Resignation Exercise within the notice period Lapse
Death or Disability Exercise within 3 months of the event Exercise within 3 months of the event
Retirement Exercise on or before the last working day Lapse
Employee Friendly
Event Vested Unvested
Termination with Cause Exercise immediately Lapse
Termination without Cause Exercise immediately Lapse
Resignation Exercise immediately Lapse
Death or Disability Exercise within 6 months of the event Exercise within 6 months of the event
Retirement Exercise within 6 months of the event Exercise within 6 months of the event

What does Cause in the above scenario mean?

If your employment agreement has a definition of cause, you could consider including that. If not, then we would recommend the following definition:

“Cause” shall include:

  • Wilful insubordination or disobedience, whether or not in combination with another, of any lawful and reasonable order of a superior.
  • Theft, fraud, misappropriation, embezzlement, moral turpitude or dishonesty in connection with the employer’s business or property.
  • Habitual absence without leave, overstaying the sanctioned leave without sufficient grounds, or proper and satisfactory explanation, or habitual late attendance.
  • Commission of any act subversive of discipline or good behavior on the premises of the Company, such as, drunkenness, riotous, disorderly or indecent behavior, gambling or taking or giving bribes or any illegal gratification whatsoever.
  • Disregard of the rules of the Company.
  • Disclosing to any unauthorized person any confidential information with respect to the Company and/or its business and/or its operation, including but not limited to trade secrets, intellectual property etc.
  • Commission or attempt to commit any cyber-crime.
  • Proven instance of sexual harassment.
  • Any other grounds that results in the Board of Directors of the Company to conclude that the act or omission by the concerned person may result in loss, damage or injury to the Company.