Companies in the twenty-first century use unique workforce retention strategies, especially long-term incentives that involve direct/indirect co-employee ownership. This post aims to discuss the regulatory framework governing share-linked and share-based employee benefits that companies offer.[1]
Co-employee ownership a means for workforce retention?
Currently, one of the most common strategies for workforce retention is providing employees with long-term incentives. When lawyer and economist Louis O. Kelso designed an employee stock option plan in 1956, it gave birth to the concept of long-term incentives as co-employee ownership, which is directly/indirectly offering employees equity in the company they work for. Kelso’s idea appears to have reimagined the employment-retirement concept and encouraged employees into long-term engagement with their employer companies by shifting their participation in the company’s value chain from employing their ‘labour’ to employing their ‘capital’.[2]
Companies have introduced various long-term incentives for such a shift to occur. Today, these could be cash- or share-based. ‘Share-based’ benefits give the holder the option to acquire the company’s shares – employee stock options (“ESOPs”), employee stock purchase scheme (ESPS), stock appreciation rights (“SARs”), restricted stock units (RSUs), performance stock units (PSUs), phantom stock units, save-as-you-earn share schemes (ShareSave), non-qualified stock options (NSOs), management stock options (MSOPs), etc. ‘Cash-based’ benefits, such as phantom stocks, are purely settled in cash. These could be ‘share linked’, in that while the benefits could be settled in cash, their quantum, determination, etc., would be linked to the company’s shares (e.g., phantom stocks). The primary reason for the boom in the use of ‘cash-based share-linked’ benefits is that companies have a lot of leeway when it comes to determining grants, eligibility, terms of the benefits, etc., because these are largely unregulated.
Evolution of India’s regulatory position on share-based employee retention strategies
The first regulatory framework to expressly call out and regulate/enable share-based employee benefits was the Securities and Exchange Board of India (“SEBI”) when it released the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme), Guidelines, 1999. On December 13, 2000, the Ministry of Corporate Affairs (“MCA”) amended the Companies Act, 1956, which did not originally have any language to expressly regulate/enable ESOPs vide the Companies (Amendment) Act, 2000, to expressly include ESOPs.[3] Interestingly, after 1999–2000, in the next regulatory overhaul in 2013–2014, changes to the regulatory framework governing share-based employee benefits offered by equity listed and unlisted companies ran parallelly again. First, the Companies Act, 2013, of August 29, 2013, introduced an inbuilt regulatory framework for ESOPs for equity unlisted companies. Next, SEBI released the SEBI (Share-Based Employee Benefits) Regulations, 2014.
Extant regulatory framework for equity unlisted companies
The Companies Act, 2013 (“Act”), read with the Companies (Share Capital and Debentures) Rules, 2014 (“SCD Rules”), regulates the share-based benefits that equity unlisted companies offer. While the SCD Rules only refer to ‘employee stock options’, it impliedly includes the reference to other share-based benefits offered by the company, as long all conditions under the SCD Rules are met.
Extant regulatory framework for equity listed companies
The Securities and Exchange Board of India (Share-based Employee Benefits and Sweat Equity) Regulations, 2021 (“SEBI SBEB&SE Regulations”),[4] regulates share-based schemes offered by an equity listed company. The SEBI SBEB&SE Regulations expressly regulate “(i) employee stock option schemes; (ii) employee stock purchase schemes; (iii) stock appreciation rights schemes; (iv) general employee benefits schemes; (v) retirement benefit schemes; and (vi) sweat equity shares”[5]andany other similar schemes, which, among other things, involve “dealing in or subscribing to or purchasing securities of the company, directly or indirectly”.[6]
Key considerations for equity unlisted companies offering share-based employee benefits
| Consideration | Regulatory threshold |
| Embargo on who can be issued share-based benefits | The company can issue share-based benefits only to ‘employees’[7] defined to include a permanent employee or a director of the company, its subsidiary, or holding company(ies).[8] |
| Determination of the exercise price | The company has the discretion to determine the exercise price, provided this is done in compliance with applicable accounting policies, if any.[9] However, typically the exercise price for any share-based benefit is not below the face value of the equity shares of the company. |
| Determination of the vesting period | While thereis no pre-set upper cap or limit on the vesting period, the company should mandatorily provide for a minimum 1-year cliff period.[10] The SCD Rules provides that in the event of death[11] or permanent incapacity,[12] all the benefits/ESOPs would vest as on the date of death/permanent incapacity. However, the SCD Rules do not clarify if the death or permanent incapacity occurs within 1 year from the date of grant, where the vesting will still occur on such a date or if the 1 year must elapse before it can vest. |
| Cap on quantum of benefit that can be offered to per employee | In a year, the company can only make a grant equal to or exceeding 1 per cent of its issued capital (excluding outstanding warrants and conversions) per employee, if it has obtained shareholder approval for the same by way of a separate resolution.[13] |
| Amending the employee benefits scheme | The company cannot make any amendment to its employee benefit scheme unless it has obtained shareholder approval by way of a special resolution.[14] Further, it cannot make any amendment that could be considered prejudicial to the interests of the employees holding any share-based benefits under the scheme.[15] |
| Additional considerations for public companies | Public companies, regardless of whether they are equity listed or not, are not allowed to place any transfer restrictions on their securities, i.e., they shall be freely transferable. The only permissible restriction, per se, could be in the form of a ‘lock-in’ for the shares issued upon exercise of vested ESOPs or other similar benefits.[16] ‘Transfer restrictions’ could also be contractually imposed, if there is any contract or arrangement between two or more persons in respect of the transfer of securities.[17] |
| Additional considerations for IPO bound companies | Companies desirous of getting listed on stock exchanges in India through an initial public offering (“IPO”) would have to be mindful of the fact that they will be required to comply simultaneously with the applicable pre-listing and post-listing regulatory framework governing share-based benefits ahead of undertaking their IPO. This is to ensure that the companies are compliant with the applicable SEBI SBEB&SE Regulations as on the date of their IPO. Companies usually do this by including explicit language in their share-based benefits schemes and policies to cover for pre-listing (essentially covering the status quo, i.e., in compliance with the Act and SCD Rules) and post-listing scenarios (which would bring the relevant scheme/policy in compliance with the SEBI SBEB&SE Regulations). Further, it is also crucial for an IPO-bound company to determine upfront if they intend to implement the employee benefit scheme directly or through a trust, because it would be infeasible (while permitted) to make this change post the IPO. With regard to the cash-based benefits, however, while companies are not specifically required to undertake any additional compliances from an IPO perspective, it would be advisable they revisit the governing schemes and policy documents to ensure the regulator does not misconstrue anything in the scheme/ policy as akin to a share-based benefit and have any concerns of having such incentive structures. |
Key considerations for equity listed companies offering share-based employee benefits
| Consideration | Regulatory threshold |
| Administrative oversight | Any share-based benefits scheme implemented by an equity-listed company mandatorily must be implemented by a compensation committee[18] (or the nomination and remuneration committee) constituted for this purpose by the company. Or, in the event that the scheme is being implemented through a trust, the compensation committee shall delegate the administration of such scheme(s) to the trust.[19] |
| Embargo on who can be issued share-based benefits | Similar to equity unlisted companies, equity listed companies can only issue share-based benefits to ‘employees’ which have been defined to include employees or directors of the company, or its group company(ies) including subsidiary(ies) or its associate company(ies), or its holding company.[20] Unlike SCD Rules, SEBI SBEB&SE Regulations permit grants to be made employees exclusively working with the company (as opposed to permanently working – to factor in gig workers, as new-age companies increasingly are undertaking IPOs) and the coverage has expanded to group companies (and is not limited to the holding company(ies) and subsidiary(ies)). |
| Determination of the exercise price | The company has the discretion to determine the exercise price provided this is done in compliance with applicable accounting policies, if any.[21] However, typically, the exercise price for any share-based benefit at listed company is mostly the ‘market price’ or the face value of the equity shares of the company. |
| Determination of the vesting period | Similartoequity unlisted companies, there is a minimum 1-year cliff period before which any of the share-based benefits can vest and be exercised into equity shares of the company with the exception of death[22] and permanent incapacity[23]. |
| Amending the employee benefits scheme | Similar to equity unlisted companies, shareholder approval by way of a special resolution would have to be obtained prior to making any amendment to the share-based benefit scheme, unless such an amendment is being made to meet any regulatory requirement. However, the company should ensure that the amendment “is not prejudicial to the interests of the employees”.[24] |
Key regulatory considerations for offering cash-based share linked benefits
As there is no specific regulatory framework governing cash-based and share-linked benefits for listed or unlisted companies, any such cash-based benefits would be included in the salary computation of the recipients. Hence, if any such benefits were provided to directors of public companies, they would be subject to certain caps,[25] and if they were provided to a company’s ‘key managerial personnel’,[26] they would additionally be subject to certain reporting requirements.[27]
Considering there is no restriction on ‘who’ can and cannot be offered cash-based and share-linked benefits, these can be offered to both employees and non-employees (e.g., consultants, advisors, contract workers, and gig workers) and can serve as an excellent long-term retention tool, especially given that a large part of the workforce today is not recruited/hired as ‘employees’.
Conclusion
Share-based and share-linked benefits act as a retention tool. With increasing popularity, their status has moved from being an exceptional/outlier benefit to a norm and an expectation for remuneration packages at top-tier companies and startups/new age companies. This expectation for share-based and share-linked benefits to workforce has largely been coming not only from the workforce but also from investors and the companies themselves. This is because companies are increasingly recognising the value in offering these tried-and-tested share-linked and share-based benefits as a means to retain the workforce that they recruit, train, and upskill for longer periods, thereby making their human resourcing more cost effective. Given that these long-term benefits often come with certain conditions linked to time and/or performance, they automatically thrust workforce loyalty and accelerate performance by aligning the workforce’s goals and interests with the company’s overall growth and performance. It is critical to ensure that the schemes that companies adopt to enable them to provide such long-term benefits are able to not only survive Series A funding rounds, but also go beyond the company’s IPO. This will help incentivise the workforce to look at their involvement in the company as one of co-ownership and their work as co-building through the company’s entire life cycle, thereby boosting talent retention, increasing resource optimisation, and maximising of shareholder value.
For further information, please contact:
Bharath Reddy, Partner, Cyril Amarchand Mangaldas
bharath.reddy@cyrilshroff.com
[1] To read about the regulatory framework governing employee benefits offered by/in foreign companies to employees of their group companies in India check out our blog here – Employee Share-based Incentives by foreign companies for employees of group companies in India: Should it be an ESOP, RSU, ESPS, SAR or Phantom Stock?
[2] Page 190-191, Louis O. Kelso, Mortimer J. Adler, ‘The Capitalist Manifesto’.
[3] Section 2(15A) Companies Act, 1956 which defined the term ‘employees stock option’ to mean “the option given to the whole-time directors, officers or employees of a company, which gives such directors, officers or employees the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a pre-determined price”. However, pertinently there was no clear regulatory framework in place under the Companies Act, 1956, and the term ‘stock option’ was only used under Section 77A – Power of company to purchase its own securities (where it provided, among other things, that ‘employee stock options’ would qualify within the ambit of ‘specified securities’ for the purpose of Section 77A, that there was no embargo on the company to buy back securities issued pursuant to an employee stock option scheme, and that there was no embargo on issuance of shares pursuant to exercise of an employee stock option after the company had completed a buy back); in relation to certain disclosure requirements under Part II of Schedule VI which provided the form for statement of profit and loss; and in relation to disclosures in relation to the remuneration of a managing director, whole time director or manager under Part II of Schedule XIII.
[4] Conjunctive reading of Section 62(1)(b) of the Act and Rule 12(11) of the SCD Rules.
[5] Regulation 1(3) of the SEBI SBEB&SE Regulations.
[6] Regulation 1(4)(ii) of the SEBI SBEB&SE Regulations.
[7] Section 62(1)(b) of the Act. ‘Employee’ is defined under Rule 12(1) of the SCD Rules as
[8] Rule 12(1) of the SCD Rules defines ‘employee’. It is pertinent to note that an ‘employee’ for the purpose of being granted share based benefits by an equity unlisted company cannot include (i) an employee who is a promoter or a person belonging to the promoter group; or (ii) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten per cent of the outstanding equity shares of the company or (iii) an independent director.
[9] Rule 12(3) of the SCD Rules.
[10] Rule 12(6)(a) of the SCD Rules.
[11] Rule 12(8)(d) of the SCD Rules.
[12] Rule 12(8)(e) of the SCD Rules.
[13] Rule 12(4)(b) of the SCD Rules.
[14] Rule 12(5)(a) of the SCD Rules.
[15] Rule 12(5)(a) of the SCD Rules.
[16] Rule 12(6)(b) of the SCD Rules.
[17] Section 58(2) of the Act.
[18] Regulation 5(2) of the SEBI SBEB&SE Regulations stipulate that “the compensation committee shall be a committee of such members of the Board of Directors of the company as provided under regulation 19 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended from time to time: Provided that a company may also opt to designate its nomination and remuneration committee as the compensation committee for the purposes of these regulations”
[19] Regulation 5(2) of the SEBI SBEB&SE Regulations.
[20] Regulation 2(1)(i) of the SEBI SBEB&SE Regulations. It is pertinent to note that the following persons are not eligible for receiving share based benefits from an equity listed company – (a) an employee who is a promoter or a person belonging to the promoter group; or (b) a director who, either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten per cent of the outstanding equity shares of the company; or (c) a director who is not a promoter or member of the promoter group, or an independent director.
[21] Rule 12(3) of the SCD Rules.
[22] Regulation 18(1) of the SEBI SBEB&SE Regulations.
[23] Regulation 18(1) of the SEBI SBEB&SE Regulations.
[24] Regulation 7(1) of the SEBI SBEB&SE Regulations.
[25] Section 197 of the Act prescribes the overall maximum managerial remuneration and managerial remuneration in case of absence or inadequacy of profits.
[26] Section 2(51) of the Act defines ‘key managerial personnel’ of a company as “(i) the Chief Executive Officer or the managing director or the manager; (ii) the company secretary; (iii) the whole-time director; (iv) the Chief Financial Officer; (v) such other officer, not more than one level below the directors who is in whole-time employment, designated as key managerial personnel by the Board; and (vi) such other officer as may be prescribed”.
[27] Remuneration of ‘key managerial personnel’ would have to be calculated and disclosed in compliance with the provisions of the Act for unlisted companies and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 for listed companies.
