Even ESOPs Have a Flipside, Are You Prepared?

These days, an offer letter without a footnote on employee stock options is like an angle without bait. But let’s face it. Not everyone who has got stock options goes home happy. Many employees across organisations feel they have got a raw deal in their options. Sometimes, a stock market that fell after the exercise of the options is the reason. More often, it is about the number of shares one got or the price at which they were issued. In such cases, employers and employees differ on their interpretation of the ESOP clauses and the result is bitterness on both sides. There are at least six traps that they must avoid to make the most out of stock option plans.

Will They, Won’t They?
The appointment letter of an employee assured him that the company would grant him options soon. Based on this, the employee gave up his options with his current employer and joined the company. But after a year, he was still waiting for the options because the board of directors had not yet approved the scheme. In India, many things work on good faith. But this opens up a landmine of confusion.

Tip for the Smart Executive: Enquire if an ESOP scheme is already in place. Get the commitment in writing. Do not leave anything to be sorted out after you have joined. Ask how the quantum of options will grow as you move up in the company. If you can afford it, hire a lawyer to vet the clauses. A promoter’s word will not suffice because ESOPs are decided by the company’s compensation committee, bound by pre-set norms. Don’t go by oral promises.

How Many?
A company promised an incoming senior executive that it will give him two percent of the paid-up capital after three years from the date of grant. By the time the options vested on the employee, the company’s capital had expanded significantly. The employee expected to be given two percent of the new capital, while the company issued shares as per the capital at the time of joining. If the company had specified the number of shares it intended to issue, this confusion could have been avoided.

Tip for the Smart Executive:  Insist on exact figures. Make sure you look at the number of shares being offered as a percentage of the total to get a better understanding of what is being given to you.

How Valuable?
A company promised to grant the employee ESOPs worth Rs. 10 lakh on the date of grant. The employee thought he will get shares worth that much without paying anything.  But the company had meant that the employee will make a benefit (potential market price — exercise price) of Rs. 10 lakh when the options vest. The  confusion here was on two counts. He believed he didn’t have to pay to get the benefit. And he also thought this was an assured benefit, irrespective of the company’s performance and stock price movements.

Tip for the Smart Executive: The current tax regime isn’t conducive to options being granted at a discount to market price. Options granted at the market price have no value on the grant date.

How to Sell?
An unlisted company, while granting options, did not clearly mention the exit route for the employees, in case its shares were not listed. During the vesting period, the company grew at impressive pace but was not listed due to unfavourable market conditions. The employee wanted to encash the value of his options but the firm said it could not do anything since there was no market for its shares.

A company must define all the possible exit options and rank them sequentially. If the initial public offering is the only exit route offered, it should be mentioned clearly. The company must also
detail the uncertainty relating to stock market listing.

Tip for the Smart Executive: Before joining an unlisted company, do a thorough due diligence. Also, think of all possible downsides beside the upsides. The market can be ruthless and the IPO may never happen. Then, what is the value of the paper you hold? Insist on a non-listing exit option.

What Price?
Another unlisted company offered a non-listing exit option, but there too, left a pitfall. It offered to buy back the shares from the employees if the company had not listed on the exchanges by the exercise date. However, it failed to specify the price. It did not mention the method of calculation either. Later, when an employee tried to sell back his shares, he found out that the price offered by the company was much lower than his expectation.

Tip for the Smart Executive: At the very beginning, ask the company for the method of valuation if the shares were to be sold back to it. Usually, the valuation is done by an independent agency.  Get the details clarified.

Leave and Be Damned
A senior executive quit a multinational to join an Indian conglomerate starting a telecom venture. After joining, he saw that there were disputes between the promoters and the CEO. Not wanting to continue in this environment, he quit. He expected to get all the benefits accrued to him during his stay, including ESOPs. But to his horror, the promoters  denied them, claiming it was not a case of resignation. The issue remains in dispute.

Tip for the Smart Executive: Negotiate for clear severance terms. Determine what will happen to ESOPs in  case of unexpected events such as bankruptcy.

Stock option plans go awry when the employers commit the sin of over-promise and the employees that of over-expectation. The only redemption is due diligence.

Did You Know?
Now cricketers would also get ESOPs. The management of Deccan Chargers IPL cricket team have indicated that they will grant stock options to their players when they go public


Author is the Managing Director, ESOP Direct