Share Based Employee Benefits are different types of options and schemes framed by companies for the benefit of their employees which involve dealing in shares of the company, directly or indirectly (“Plans”).1 This is a benefit wherein rights and benefits linked directly or indirectly to shares are offered to the directors, officers or employees of a company or its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.2
In the recent years, especially when the world is fighting the Covid-19 pandemic, more and more companies are including such Plans as a part of the remuneration offered to employees. However, more often than not, there is a vast difference between the value of the stock appearing in the offer letter of the employee and the actual value that the employee receives from sale of the stock.
While the Securities Exchange Board of India regulates the share-based employee benefits offered by public companies through SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SEBI Regulations”), the same does not apply to private limited companies which are still governed solely by the Companies Act, 2013 and the applicable rules and regulations. The Companies Act does not provide for regulation of Plans by any authority which thereby allows private companies much more liberty as compared to the public companies to frame their employees’ stock benefit plans. Due to this reason, a lot of such plans offered as part of remuneration to employees are not as lucrative as they may seem on paper and there are a lot of hidden terms and conditions which need to be understood by employees before accepting the same:
Understanding the type of Plan being offered
The first and foremost thing that needs to be understood by the employee is the type of Plan being offered and the rights that are being offered to him under the same. The SEBI Regulations define the different types of plans:
- Employee Stock Option Scheme is a scheme under which a company grants employee stock options to employees directly or through a trust. Employee Stock Purchase Scheme is a scheme under which a company offers shares to employees, as part of public issue or otherwise, or through a trust where the trust may undertake secondary acquisition for the purposes of the scheme.
- General Employee Benefits Scheme is any scheme of a company framed in accordance with these regulations, dealing in shares of the company or the shares of its listed holding company, for the purpose of employee welfare including healthcare benefits, hospital care or benefits, or benefits in the event of sickness, accident, disability, death or scholarship funds, or such other benefit as specified by such company.
- Retirement Benefit Scheme is a scheme of a company framed in accordance with these regulations, dealing in shares of the company or the shares of its listed holding company, for providing retirement benefits to the employees subject to compliance with existing rules and regulations as applicable under laws relevant to retirement benefits in India.
- Stock Appreciation Right is a right given to a stock appreciation right grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company.
As can be seen from the above listed plans, there are different rights and options available under each such plan. Some plans provide for direct issuance of shares of the company while certain others only offer the monetary benefits accruing from the shares and not the possession of shares per say. The employees need to then decide what rights would they want if they are allowed participation in such plans and whether the same is offered in the plan formulated by the company or not.
Class of Shares being offered Shares are generally differentiated into different classes based on the rights associated with the shares. This is a common method used by shareholders in a company to ensure that voting rights and control of the company do not pass on to employees by virtue of allotting them shares under these Plans. However, without control and voting rights, the shares are essentially useless in the absence of the company buying back the option. This is so because if the company is ever sold to investors in the future, the investors would only be interested in buying that class of shares which would provide them control in the company and consequently, the class of shares which do not provide for the same would not be preferred.
Vesting Period Vesting is the process by which the employee becomes entitled to receive the benefit of a grant made to him under any of the Plans. The stock options offered to employees are generally framed in a manner whereby the shares vest over a period of time. While this is beneficial from the company’s perspective for ensuring that the employee remains with the company for a longer period of time, however, from the employee’s perspective, this ties the employee to the company. The minimum vesting period prescribed is 1 year from the grant of the option.
Lock in Period Lock-in period is the time period during which the shares vested with an employee cannot be sold. Companies have a right to specify the lock-in period in respect of the shares vested with the employees. Employees need to ensure that the same is not for an arbitrarily long time. A lock-in period of 1 year is the general market standard. However, the employee should check if there are exceptions carved out against the lock-in period. Such exceptions would include among other things allowing the employee to exit along with other shareholders in the event of an initial public offer or in the event of future investors investing in the company.
Exercise Period Exercise period is the time period after vesting within which an employee can exercise his right to apply for shares against the vested shares/rights. The shares/rights under the Plan do not automatically devolve to an employee after the vesting period and the employee needs to exercise the same. If the employee fails to exercise his right within the exercise period, he loses his right over the shares/rights provided to him under the Plan.
Exit Rights The exit rights provided for under the Plan are the most crucial for an employee in a private company as they are the only way by which the employee can sell his shares or encash his rights. There are different ways in which exit rights may be provided for, wherein the company may:
- provide for buying back the employee’s shares; or
- allow for encashment of his rights; or
- allow the employee a right to sell his shares to new investors; or
- allow the employee to sell his shares at initial public offer.
Employees need to ensure that they have proper exit rights available and are not stuck with shares/rights that they are unable to exercise. Another important factor is the time period within which they will be able to exercise the exit rights. Further, the exit rights should not be tied up to the possibility of any particular event nor should there be an expiry on the same.
The knowledge of all these aspects would help better ensure that employees know exactly the type of benefits that are being offered and this can help employees better negotiate rights under the same. It is also important for employees to remember that not all Plans turn out profitable for employees and Plans should only be accepted if the employees are willing to take this risk.
1 SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021
2 Section 2(37), Companies Act, 2013.
3 SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021