Regulatory Compliances for Equity Compensation in India

In the last blog of our ESOP 101 series, "What is equity compensation?", we covered the different types of equity-based compensation structures. However, before implementing any such scheme in your organization, it is essential to understand the relevant regulations and eligibility criteria.

The Companies Act of 2013 and the Companies (Share Capital and Debentures) Rules of 2014 outline the legal requirements for issuing equity to employees in private companies. Listed companies must also comply with the Securities and Exchange Board of India (SEBI) Employee Stock Option Scheme Guidelines.

It's important to note that Indian company law only recognizes employee stock option plans (ESOPs) and sweat equity as valid stock-related compensation methods. Stock appreciation rights (SARs) and restricted stock units (RSUs) are not formally recognized.

Who is eligible for equity compensation?

ESOP eligibility

According to Rule 12(1) of the 2014 Companies (Share Capital and Debentures) Rules, the following employees are eligible to receive ESOPs:

• Permanent employees of the company, working either in India or abroad.

• Directors of the company, including whole-time and part-time directors, but excluding independent directors.

• Permanent employees or directors of a subsidiary, holding, or associate company, whether in India or abroad.

However, the following employees are not eligible for ESOPs:

• Employees who are promoters or belong to the promoter group.

• A director who, either personally, through a corporate entity, or via a relative, holds more than 10% of the company's outstanding equity shares, whether directly or indirectly.

Note: These conditions do not apply to startups registered under the "Startup India Initiative" for 10 years from their incorporation.

A startup is defined as a company whose annual turnover is under ₹100 crore in any financial year and the company should focus on innovation, intellectual property, and developing new products with strong potential for job creation.

Sweat equity eligibility

In accordance with the provisions of subsection (1) of section 79A of the Companies Act, 1956 (1 of 1956), along with subsection (1) of section 642 of the same Act, the following employees are eligible for sweat equity:

• Permanent employees of the company, working in India or abroad

• Directors employed as whole-time or executive directors

• Employees or directors of a subsidiary or holding company, either in India or abroad

Necessary disclosures

Disclosures needed to issue ESOPs  

When issuing ESOPs, a company must disclose the following details in the explanatory statement attached to the notice for passing the special resolution:

• Total number of stock options to be granted

• The identified class of employees eligible to participate in the ESOP

• Vesting period requirements

• Maximum period within which options can vest

• Exercise price and its process

• Lock-in period, if any

• Maximum number of options granted per employee and in aggregate

• Valuation methods used by the company

• Conditions under which vested options may lapse (e.g., termination for misconduct)

• Timeframe for exercising vested options in case of employment termination or resignation

• A statement confirming compliance with applicable accounting standards by the company

Disclosures needed to issue sweat equity

At the time of a general meeting called for the issuance of sweat equity, the company must disclose the following:

• Total number of shares to be issued as sweat equity

• Class of directors or employees eligible for the issuance

• Principal terms and conditions, including the basis of valuation

• Time of association of the person with the company

• Names of directors or employees receiving sweat equity and their relationship with the promoters or key managerial personnel

• Price of the sweat equity shares

• Consideration for the sweat equity, including non-cash considerations

• Whether the ceiling on managerial remuneration will be breached and how it will be addressed

• A statement confirming compliance with accounting standards

• Diluted earnings per share, calculated in accordance with applicable standards

For startups, as defined by the Department for Promotion of Industry and Internal Trade (DPIIT), the issuance of sweat equity shares can be up to 50% of the paid-up capital within five years from the date of incorporation or registration.

What about SARs?

Stock Appreciation Rights (SARs) have gained popularity in India as an equity compensation offering. Under Regulation 2(1)(qq) of the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 ("SEBI Benefits Regulations"), SARs are defined as the right to receive appreciation for a specified number of shares. This appreciation may be settled in cash or company shares.

Issuing SARs by an unlisted company remains unregulated and unrecognized under the SEBI Benefits Regulations or the Companies Act. However, there has been some progress. 

The Ministry of Corporate Affairs (MCA), under the report of the Company Law Committee published in March 2022, recommended that:

“The Committee was of the opinion that RSUs and SARs should be recognized under CA-13 through enabling provisions. If these schemes require the issue of further securities by the company, their issuance must be allowed only after approval of the shareholders through a special resolution. However, where the settlement of such rights does not involve offer or conversion into securities, approval by shareholders need not be mandated.”

While unlisted Indian companies can issue SARs, it is recommended to follow SEBI rules as a good practice.

We hope you found this post helpful, do reach out to us if you have any questions.