The Procedure of ESOP for Startups and its Advantages
Studies reveal that the number of startups in India has grown exponentially in recent years. To outdo the competition and be successful, startups need systematic planning of resources by getting the right assets and tools, along with an efficient team. Retaining existing employees by leveraging innovative methods of compensation, such as Employee Stock Option Plan or ESOP for Startups, is essential for a business’ success.
ESOPs allow employees to purchase a company’s shares at a discounted rate. They provide several benefits to startups like helping them hire the best people and retain them for a longer period. They also make the employee a part-owner of the startup and a co-creator in the business.
How Companies Allot ESOPs
A majority of startups are private limited companies regulated by the Companies Act 2013. ESOP for startups empowered by the Act allows directors, officers, and other employees of a company, its subsidiary, or its holding companies to subscribe to the company share at a predetermined price at a future date. The face value of the share could be the predetermined value. For example, a share with market value Rs. 500 could be available to employees at Rs. 10. The difference in values Rs. 490 is the benefit the employee acquires.
ESOPs enable a private limited company’s employees to become the firm’s shareholders. For companies, whose shares are listed, the ESOPs shall be issued according to SEBI regulations. But, the employer does not compulsorily have to buy the shares. It is up to the employee whether to exercise his option or not.
Steps a Company Should Take after a Feasibility Study
A company should conduct a feasibility study to decide whether the ESOP is financially viable. After the study shows positive results, the company should:
- Prepare an ESOP scheme and obtain the shareholder’s approval after proposing it in a shareholder’s meeting.
- After approval, the company gives employees a Letter of Grant, giving them stock options. The letter will contain information like vesting exercise period, exercise period, and more.
Once the vesting period is completed, employees can exercise the option to become the company’s shareholders.
Advantages of ESOP for Startups to Employees
ESOP for Startup provides the following benefits to the employees:
- They can make a profit by selling profitable shares that they purchased at a low rate.
- By owning the shares, employees can also be a part of the firm’s success.
- The employees feel motivated to give 100% to their work.
Advantages of ESOP to a Company
Through ESOPs, a company gets these benefits:
- Employee turnover rate reduces, and they work for longer periods.
- A private limited company saves money spent in director remuneration by offering ESOPs as part of the salary.
- It enables companies to boost their employees’ morale and help inspire them to give their best to their daily tasks.
ESOP and Taxation for Employees
Employees availing of ESOP to buy shares will have to pay taxes for the shares as per the Income Tax Act 1961.
The tax liability arises for employees at these stages:
1. When they convert ESOP to shares: Employees are liable for tax once they convert their ESOP option to equity after the vesting period. The tax is levied on the perquisite value under the head ’Income from Salary’. The company calculates the perquisite ESOP value given to the employee, on which the tax is deducted.
The taxable value computation is as follows:
- The share’s fair market value at the date of exercising the option
- Minus the amount paid by the employees for the shares
2. On selling the shares: Tax is levied when the employee gets capital gains after selling the allotted shares at a higher rate. These are calculated as either short-term or long-term capital gains, and the type of capital gain determines the tax rate.
The capital gain calculation is as follows:
- The share’s selling price.
- Minus the share’s the fair market value on the date of exercising the option.
ESOP for startups makes the firm’s employees feel inspired to give their best and make them feel proud they are part of the firm’s success. It is an excellent way to retain employees who contribute significantly to their company. 3E Accounting’s expert team of qualified professionals, with several years of experience, provides high-quality business setup services to startups in India. We are leading Business setup specialists in India and help firms draft an ESOP that is compliant and also tax-efficient. We provide the best solutions to firms on all taxation, accounting, and company incorporation matters. For all your queries regarding our services, please feel free to contact us.