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.

 

 

Applying for Trademark? Here is how you can get a proprietor code

Before creating a Proprietor Code you need to ensure that you have a valid Class III Digital Signature Certificate and the same is installed on your computer.

Proprietor Code can be created online on the Trademarks Registry’s Website. To create a Proprietor Code you need follow the below steps.

  1. Go to http://www.ipindia.nic.in/
  2. Click on Trademarks;
  3. On the next page, click on Comprehensive eFiling Services for Trade Marks;
  4. On the next page, click on No Account? Sign Up;
  5. On the page, click on Proceed for Registration;
  6. The Next Page will display the New User Registration Form; on this page, select “Proprietor” in the type of Applicant and in the Enter Code box, type your (applicant’s) name and click on Search;
  7. On the next page, type your (applicant’s) name in the box and click on Submit;
  8. On the next page, click on Add New;
  9. On the next page, select the Proprietor Category and fill up the form, the form requires basic details like:
    • Name;
    • Address;
    • Nationality;
    • Service Address (where you want all notices to be served);
    • Telephone:
    • Fax;
    • E-mail;
    • Trade Description (Brief description of your business);
    • Trading As (Business Name);
    • Legal Status (Company, LLP, Partnership Firm, Trust, etc.).
  10. Once you have filled the form, click on Submit and a Proprietor Code will be generated.

You need to mention the same Proprietor Code, for all applications made under the same name.

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.

Is Your ESOP Grant Really an ESOP Grant or Just an Offer?

I was talking to a startup founder about ESOPs and he very proudly informed me that he has given ESOPs to his employees. I must say I was impressed! The reason being, this friend of mine had incorporated his start-up only 6 months back and although he had been hiring aggressively, I didn’t think he had the bandwidth to set up a ESOP Policy to give the employees the ESOP benefits. On further probing, he very innocently explained to me that he had indicated the no. of ESOPs for each employee and other details of the ESOP grant in their respective offer letters. Therefore in his opinion, he had completed the daunting task of “granting” ESOPs.

Well, he is not the only one! Most entrepreneurs think they have granted ESOPs just because they have mentioned the same in the offer letter or employment agreement of their employees, without realizing that under the Indian laws (more specifically, the Companies Act, 2013), for a company to grant ESOPs to its employees, the company has to first create a ESOP Policy, which has to be approved by the Board of Directors and Shareholders of such company.

EMPLOYEE STOCK OPTIONS – LIFECYCLE

ESOP POLICY – HOW IT WORKS

The law has a very specific ESOP definition and prescribes all the terms that need to be included in a ESOP Policy. You should therefore ensure that you include the following terms in a ESOP Policy:

  1. Total number of ESOPs to be granted
  2. Identification of classes of employees entitled to participate in the ESOP Policy
  3. Requirements of vesting and period of vesting
  4. Maximum period within which the ESOPs shall be vested
  5. Exercise price
  6. Exercise period and process of exercise
  7. Lock-in period, if any (lock-in period means the period during which the employee is not entitled to transfer the shares issued to him upon exercise of the vested options)
  8. Conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct
  9. Specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee.

OFFER LETTER = ESOP GRANT?

Sorry for the digression. Coming back to my friend’s example. He had not created a ESOP Policy, but had just mentioned ESOPs as part of the compensation package for his employees, in their offer letter. This did not mean that the employee had been given or “granted” ESOPs. An employee officially gets ESOPs only when the company, after creating a ESOP Policy (duly approved by Board and Shareholders) issues a letter to the employee indicating the exact no. of ESOPs being given to the employee and the terms of such ESOPs. Till the time you, as a company have completed these formalities, you have only promised ESOPs to employees and not granted them ESOPs!

Also remember, delay in granting ESOPs would result in delay in vesting of ESOPs to employees, as there is a mandatory 1 year cliff on ESOPs under the Companies Act, 2013. So, a delayed ESOP grant means a delay in ESOP benefits accruing to the employees.

 It is therefore important for every startup to create ESOP Policy at the earliest and actually grant ESOPs to their employees! #StartRight_RightNow! 

Tax Implications of Stock Incentives

EVENT TAX IMPLICATION ON EMPLOYER TAX IMPLICATION ON EMPLOYEE
Granting of ESOPs, i.e., when the company/startup issues a grant letter to the employee setting out details of ESOPs granted to the employee. NIL

 

(This is because there is no monetary transaction being conducted at this stage. Additionally the employee only gets an option to buy shares at the time of grant)

Vesting of ESOPs, i.e., when employee fulfills the conditions stated in the grant letter and becomes eligible to purchase shares of the company) NIL

 

(This is because there is no monetary transaction being conducted at this stage. Additionally the employee only gets the right to buy shares at this point)

Exercise of ESOPs, i.e., when the employee actually purchases shares in the company/startup Employer may have to deduct TDS (withhold tax) on the additional perquisite value, in accordance with Section 192 of the Income Tax Act, 1961. Difference between the Fair Market Value (“FMV”) of shares on the date of exercise of option and amount paid by employee, shall be taxable as ‘perquisite’ under Section 17(2)(vi) of the Income Tax Act, 1961.
Sale of shares (where shares were held for less than 36 months by the employee), i.e., when the employee sells shares held by him NIL Difference between the sale price and the FMV of shares on the date of exercise would be treated as short-term capital gains. Gains would be taxable as per the ‘normal slab rate’ applicable to an individual under the Income Tax Act, 1961.
Sale of shares (where shares were held for more than 36 months by the employee)  i.e., when the employee sells shares held by him NIL Difference between the sale price and the FMV of shares, on the date of exercise would be treated as long-term capital gains.

 

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 or holds equity in 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 the DIPP, Government of India to grant ESOPs to Promoters, 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 DIPP, Government of India, then you can grant ESOPs to Promoters/Co-founders.