ESOP – An effective tool for Employee Compensation

Posted by finvalresearch Comments Off on ESOP – An effective tool for Employee Compensation Valuation

ESOP – An effective tool for Employee Compensation

Employee Stock Ownership Plan (“ESOP”) are one of the prominent instruments used in the corporate and start-up world to attract, retain and motivate the high skilled and talented personnel of the business. ESOP motivates the employees to drive the performance of the organization, resulting in maximization of shareholder’s value and thereby align the employees’ interest with that of the organization.

ESOPs are a handy tool for cash strapped but high potential start-ups and MSMEs to compensate their key employees handsomely and also keep them motivated. Some of the benefits of ESOPs are as follows:

• Employees have a sense of ownership of the company
• It aligns employee interest with the objectives of the company
• Reduces cash outflow for the company
• Employees are rewarded as their performance helps in company’s growth and valuation
• A longer vesting period helps in employee retention

ESOPs are issued by means of a written agreement with the employees. Some of the significant terms generally used in these agreements are as follows-

• Grant Date: means the date fixed by the Company or the Board, to be the date on which the scheme is extended to any employee. The date would be specified in the offer letter issued to the employee.
• Vesting: The process by which the employee becomes entitled to receive the benefit of the grant made to him.
• Vesting period: This is the period during which the vesting of ESOP takes place.
• Vesting date: The date on which the employee becomes entitled to receive the shares under the option.
• Exercise Price / Strike Price: Amount which the employee is required to pay to receive the shares under the option.
• Exercise Period: The period during which the employee is eligible to exercise his right to receive the shares under the option.
• Exercise Date: The date on which employee exercises his right to receive the shares.
• Lock-in Period: This is the period from the date of allotment of shares, during which the employee is prohibited from selling the share. This is specified in the offer letter issued to him.

ESOP are issued under the ESOP scheme (“ESOS”) formulated by a listed company in accordance with SEBI ESOS Guidelines and by an unlisted company in accordance with Rule 12 of Companies (Share Capital and Debentures) Rules, 2014. The accounting treatment of ESOP issued by an Ind-AS compliant company is governed by Ind-AS 102 ‘Share Based Payment’, whereas companies complying with Companies (Accounting Standards) Rules, 2006 shall apply ‘Guidance Note on Accounting for Employee Share-based Payments’ issued by ICAI for ESOP accounting.

The need for valuation during the lifetime of an ESOP arises from the following events

1. Grant Date – To measure the Stock Compensation to be recognized in the books of accounts as per the Ind AS 102 and Guidance Note issued by the ICAI – To be done by Registered Valuer
2. Vesting Date/Exercise Date – To measure the perquisite value as per the Income Tax Act – To be done by a Merchant Banker
3. Reporting Date – For cash settled ESOPs (i.e. where employees are paid the differential cash in place of equity on the exercise date), the ESOP liability need to be valued on fair value basis on each reporting date.

Please reach out to us on valuation@finvalresearch.in for any requirements on ESOP Structuring and ESOP valuations.