SEBI new guidelines defines an employee eligible for ESOP

Employee Stock Options (ESOPs) are widely used ways to reward, retain, and motivate employees. However, the requirement that ESOPs can only be allocated to employees can present challenges and limit its applicability. Therefore, SEBI has introduced its informal guidelines on the definition of an employee.

As reported by Deccan Herald, SEBI was asked for ’informal guidance’ regarding whether or not doctors who work part-time for a company while also engaging in private practice and earning other income be considered employees and therefore eligible for ESOPs.

On January 27, SEBI provided a favourable response in its guidance. Upon examining the definition of employees in the SEBI SBEB regulations, it was determined that individuals are not required to work full-time for the company to be considered employees. Therefore, in the aforementioned scenario, doctors would be classified as employees and eligible for ESOPs.

The report further states that it is possible to extend this interpretation to include most types of gig workers who meet these criteria. ESOPs, a mutually beneficial instrument, could be used profitably for a wider range of professions. As previously mentioned, there are adequate measures in place to prevent the misuse of ESOPs. Specifically, ESOPs can only be issued after being approved by the board of the company’s compensation committee. Additionally, any discounts offered on the issuance of ESOPs must be recogniszed as a cost.

One crucial aspect of the legal framework for ESOPs is that they can only be offered to employees, which is designed to prevent the tool’s abuse. Although ESOPs provide an opportunity for employees to acquire shares, their value comes at the expense of other shareholders, as the shares are effectively diluted. This is because ESOPs are typically exercised when the exercise price is lower than the current market price.

Therefore, it is essential to have measures in place to prevent the misuse of ESOPs. Specifically, the management and promoters should not be able to unfairly benefit from the scheme. Hence, reportedly, to ensure the proper use of ESOPs, SEBI has two safeguards in place. Firstly, promoters are not allowed to be granted ESOPs. Secondly, the issuance of ESOPs requires the approval of shareholders through a special resolution.

ESOPs allow companies to offer their employees the option to purchase shares at a predetermined price. If the value of the shares increases over time, the employees who hold these options may benefit from the increase in value, which is largely due to their contribution and work. They can exercise the options and acquire the shares at the pre-agreed price, thus capitalising on the appreciation in value. However, if the value of the shares decreases, employees do not incur any losses. They can simply choose not to exercise the option.