ESOP Liquidity Structuring in India: Understanding Surrender, Exercise, Buyback, and Secondary Share Transfer Programs

Employee Stock Ownership Plans (ESOPs) have gained significant popularity in India as an effective tool for aligning employee interests with company growth. While ESOPs offer employees the opportunity to share in the success of their organization, it is crucial to understand the various aspects of ESOP liquidity structuring. In this blog, we will explore ESOP surrender, exercise, buyback, and secondary share transfer programs in the Indian context, shedding light on their mechanics and implications.

ESOP Surrender  

ESOP surrender refers to the process by which an employee chooses to surrender their vested ESOPs back to the company. This is the most common structure used in internal liquidity rounds. In this scenario, companies would like to use its money on their balance sheet and incentivise employees with vested options to reap the benefits of ESOPs. This is the simplest of all the liquidity programs companies can choose to run.  

When an employee surrenders her ESOPs, she forfeits her stock options. The surrendered ESOPs are typically returned to the pool of unallocated options or may be redistributed among other employees. The surrender process usually involves completing specific forms and the consent to forfeit the options in lieu of the money being paid by net off the tax and exercise amount.

ESOP Exercise  

ESOP exercise refers to the process of converting vested stock options into actual shares of the company's stock. Once the ESOPs have vested, employees have the choice to exercise their options and become shareholders. The exercise price, predetermined at the time of grant, allows employees to purchase shares at a predetermined price, usually lower than the prevailing market price.

Employees exercising the options pay the exercise amount, and the perquisite tax upfront without realizing any money on the difference of prevailing market price and the exercise price.  

Recommended Reading: Why are startups opting for ESOPs?

‍

Secondary Share Transfer  

ESOP liquidity can be facilitated through secondary share transfer. A secondary share transfer takes place when there is a sale of shares from the primary owner in a company. These programs enable employees to sell their options (by exercising) or existing shares to external (or existing) investors or buyers, providing an opportunity for liquidity before an exit event or public listing.

Secondary share transfers are typically subject to regulatory requirements and often involve a formal process and multi-step workflow to engaging all the stakeholders. The company, along with the employee(s), and the investor(s) must ensure all the necessary documentation are executed to comply with the legal, regulatory, and financial aspects of share transfer. Most companies planning to run such programs will ask the employees to first exercise their vested options & do a transfer of shares to the incoming investor(s). There by helping the employees to get liquidity in lieu of their exercise.  

Many companies often establish Employee ESOP Trusts to hold shares of its stock on behalf of its employees. The trust serves as a vehicle to manage and distribute the company's stock ownership among its employees, providing them ownership and potential financial benefits. The trust greatly facilitates liquidity for ESOP participants. The trust can also serve as a buyer of ESOP shares from employees who wish to sell. By repurchasing shares, the trust helps ensure a viable means for participants who want to monetize their ESOP holdings.  
‍

Also Read: The ESOP Cheatsheet

‍

ESOP Buyback

The term "ESOP buyback" generally refers to the process where a company repurchases the shares of its employee stock ownership plan (ESOP) participants. While ESOP Buyback is colloquially used but technically it is a share buyback program. So ESOP buyback or Share buyback refers to the process in which a company repurchases its own shares from employees who have exercised their ESOPs provided that, company has free reserves and securities premium to the extent of the buyback.

ESOP buyback refers to the process in which a company repurchases its own shares from employees who have exercised their ESOPs provided that, company has free reserves and securities premium to the extent of the buyback.  

Limitations on Buyback:

The maximum limit for a company's buyback is 25% or less of its total paid-up capital and free reserves and security premium.  

Debt: Equity ratio cannot be greater than 2:1 post buyback

Fresh issue of the same class of securities is not allowed for 6 months post buyback.

Conclusion

ESOP liquidity structuring plays a vital role in the overall effectiveness and appeal of ESOPs in India. Understanding the mechanisms of ESOP surrender, exercise, buyback, and secondary share transfer programs is essential for both companies and employees.

For employees, it is crucial to evaluate the financial implications, tax considerations, and potential risks associated with each of these options before making decisions related to their ESOPs. Similarly, companies must design and implement ESOP programs with careful consideration of their long-term goals, financial resources, and regulatory compliance.

By providing avenues for liquidity, ESOP structuring contributes to employee satisfaction, talent retention, and the overall success of companies. As the landscape of ESOPs continues to evolve, it is important for stakeholders to stay updated on the latest developments and seek professional guidance when navigating ESOP liquidity options in India.

In India, the rules and regulations surrounding ESOPs are governed by the Companies Act, 2013, and the Securities and Exchange Board of India (SEBI).

To learn more about ESOP Liquidity Structuring in India, connect with us.