financial mgnt

8/2/2019 Financial Mgnt

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S.Y.B.B.I

SEM-4

SUB:FINANCIAL MANAGEMENT-II

TOPIC: EMPLOYEE STOCK OPTION PLAN &

SWEAT EQUITY

NO OF GROUP: 5

DATE OF SUBMISSION: SIGNATURE:


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MEMBERS OF GROUPS

NAMES OF MEMBERS ROLL NO

1 SIMRAN KAUR 24

2 SHRUTIKA PADWAL 25

3 SONAM TIWARI 36

4 POOJA VICHARE 37

5 SHRUTIKA WARANG 39


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INTRODUCTION

Employee Stock Option (ESOP) and Sweat Equity (SE)

are new tools, which are in use by a lot of multinational

companies and consulting companies coming to India and

engaging the real brain of Indian professionals who are

offered ESOP/SE by such companies as an incentive to

them. In absence of any set law or precedent about itslegality, taxation and accounting, a great deal of confusion

is prevailing and an attempt is made to resolve the same.

CONCEPT OF ESOP & SWEAT EQUITY

Over the years, the ESOP has taken various forms. ESOP when spelled

as Employees Stock Ownership Plans, relates to the broad and generic

meaning which covers most types of share based payments made to

employees. However, ESOP as Employees Stock OptionsPlans is one

of the mode of share based payment and hence a classification under the

generic term. In this book we will discuss ESOP as Employees Stock

Options Plans as this is most common and popular form of share based

payments to employees.


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Why ESOP or Sweat Equity ?

The employee stock option plan is a good management tool forretention of human talent and guarding against poaching of staffof a running organization by a rival company.

When a company is newly formed or starts a new line ofbusiness, the company engages the best executives andemployees available, who bring in their IPR (Intellectual PropertyRights) and know-how, skill and expertise with them, which makea value addition for the company. Certain key professionals wouldlike to invest in the companys capital and would like to risk their

own contribution to the capital of the company along with theirown IPR, know-how, skill and expertise. Such employees wouldlike to be a strategic part of the promoter group and would like tomake value addition to their capital invested in the company.Such an employee is awarded with Sweat Equity as an incentiveto join the company.

As the company grows, the management would like to see that all

its core management team remains with them and further, suchcore management team is given additional incentive as a rewardfor the efforts put in by them in managing the company. Suchemployees are offered ESOP at a price which is less than the realvalue of the share.


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EMPLOYEE STOCK OPTION PLAN

DEFINITION OF ESOP

Incentive program that give the qualifying employees theright to buy the firm's common stock (ordinary shares) at a

discount. It also called stock option plan or stock purchase plan.

Employee Stock Option Plan (ESOP), is a plan through which

a company awards Stock Options to the employees based on

their performance. Under an ESOP, the employees have right to

buy the shares of the company on a predetermined date at a

predetermined price. The objective of ESOP is to motivate the

employees to perform better and improve shareholders' value.

Apart from giving financial gains to the employees, ESOP also

creates a sense of belonging and ownership amongst the

employees.

HISTORY OF ESOP:

The employee stock option scheme (ESOS) concept was

developed in the 1950s by lawyer and investment banker Louis

Kelso, who argued that the capitalist system would be stronger if

all workers, not just a few stockholders, could share in owning

capital-producing assets. In todays world, the human capital is

unarguably one of the most important resources to run any

enterprise. Companies use untraditional methods of remunerating

employees to retain their employees and attract new employees

to their organization. Therefore, scheme like ESOS, ESPS and

sweat equity has gained popularity in recent times.
http://www.businessdictionary.com/definition/incentive-program.htmlhttp://www.businessdictionary.com/definition/qualifying.htmlhttp://www.businessdictionary.com/definition/employee.htmlhttp://www.businessdictionary.com/definition/right.htmlhttp://www.businessdictionary.com/definition/buy.htmlhttp://www.investorwords.com/1967/firm.htmlhttp://www.businessdictionary.com/definition/common-stock.htmlhttp://www.businessdictionary.com/definition/ordinary-share.htmlhttp://www.businessdictionary.com/definition/at-a-discount.htmlhttp://www.businessdictionary.com/definition/at-a-discount.htmlhttp://www.businessdictionary.com/definition/stock-option-plan.htmlhttp://www.investorwords.com/4748/stock_purchase_plan.htmlhttp://www.investorwords.com/4748/stock_purchase_plan.htmlhttp://www.businessdictionary.com/definition/stock-option-plan.htmlhttp://www.businessdictionary.com/definition/at-a-discount.htmlhttp://www.businessdictionary.com/definition/at-a-discount.htmlhttp://www.businessdictionary.com/definition/ordinary-share.htmlhttp://www.businessdictionary.com/definition/common-stock.htmlhttp://www.investorwords.com/1967/firm.htmlhttp://www.businessdictionary.com/definition/buy.htmlhttp://www.businessdictionary.com/definition/right.htmlhttp://www.businessdictionary.com/definition/employee.htmlhttp://www.businessdictionary.com/definition/qualifying.htmlhttp://www.businessdictionary.com/definition/incentive-program.html


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ADVANTAGES OF ESOPS:

ESOPs can increase employee incentive. People work

harder and are more loyal when they own part of the company.

Studies have shown a high correlation between employee

ownership and productivity.

ESOPs can be used to prevent a company shutdown by

raising money and increasing the employees' desire to be

more productive.

A retiring owner who sells more than 30 percent of thestock in a closely held corporation can defer capital gains if the

proceeds are used to invest in other securities.

They create a market for an owner's shares.

DISADVANTAGES OF ESOPS:

ESOPs cannot be used in partnerships and most professionalcorporations. They can be established in S corporations, butdo not qualify for certain "rollover" advantages of otheremployee programs.

As mentioned above, companies must repurchase the shareswhen an employee leaves. In some cases, this may meanhuge cash outlays.

They can be expensive to set up. Whenever new stock is issued, the value of the owner's stock

becomes diluted.


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DIFFERENT TERMS USED IN AN ESOP:

Grant date - The date on which the company grants an option toits employee.

Option price - The price at which such shares in a scheme areoffered. It is also known as the strike price or grant price.Normally such option price would be below the market value/ fairvalue of the shares on the date of grant.

Vesting date - An ESOP would provide for a date on which anoption is vested with employees and time frame over which thestock option would vest with employees (Vesting period).

EMPLOYEE POWER AND SUCCESS

Although ESOPS can offer a great exit strategy for owners,their impact on a company can be broad. That is why your

decision to create an ESOP must consider other factorsbesides your retirement.

If your company creates an ESOP, higher employeeparticipation is not only beneficial; it's mandatory. In privatecompanies, employees must be allowed to vote on majorissues, such as opening or closing a plant. In publiccompanies, employees must be able to vote on all issues.

So keep these factors in mind when considering an ESOP andbe sure to consult with your tax advisor and legal counselbefore creating one.


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KEY ELEMENTS OF AN ESOP:

An ESOP is essentially a tax-qualified employee profit-sharing program. It invests primarily in the employer's stockand it may own a small percentage of the stock or all of it.

All of the stock in ESOP is held in trust.

The company can contribute cash to the ESOP to buyshares, or the ESOP can borrow money to buy shares, andthen the company makes cash contributions to the plan, whichthe ESOP then uses to pay back the loan.

An ESOP is the only kind of employee benefit program thatcan borrow money.

Shares can be allocated using a variety of factors, such asseniority and pay scale.

Usually only full-time employees may buy shares.

Dividends are paid to employees in the form of cash orincreased value of the stock.

Company contributions to the plan are tax deductible, withincertain limits.

Over time, each employee gains more complete ownershipof his or her stock and must become fully vested in five toseven years.

When an employee leaves, the company must buy back theshares at fair market value


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USAGE OF ESOP

The ESOPs at present are mostly used to buyback theshare of a retiring employee and as an incentive schemefor employees. ESOPs can also be used for financing invarious areas such as financing expansion, when going foracquisition, creating a new division.

The basic purpose of ESOPs for many companies is toprovide employee benefits or incentives. As they believe

that by increased employee participation, with themperceiving themselves as owners and more involved withthe company it will lead to a positive increase in theirdedication to the company, improve work effort, reduceturnover and generally bring a more harmoniousatmosphere to the company.

EXAMPLE: In case of a retiring owner, in order to convert his paper money into

actual money he has to sell the shares to someone. If he sells to some othercompany, the income will be taxed as ordinary income or in some special cases as

capital gains. But its difficult to buy a buyer if its a closely held company. Also

there comes an issue of loyalty as the employees dont want to sell to any outsider

if it may harm their company.

Here ESOP provides a market for the equity of a retiring owneror any interested

major shareholder and provide a benefit and job security for employees in the

process. Retiring owners of closely held companies incur no taxable gain on a sale

of stock to an ESOP, provided that the ESOP owns at least 30% of the company

immediately after the sale, and that the sale's proceeds are reinvested in qualified

securities within a fifteen month period beginning 3 months before the date of the


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sale. This tax-deferred rollover is a most tax favored way for an owner of a closely

held company to sell his or her stock.

Another use of ESOPs is for financing in the form ofleveraged ESOP, where the ESOP or the company canborrow from banking or other lending institutions. Inreturn of this loan the company guarantees to makecontributions in the ESOP trust hence enabling the trustto amortize the loan.

ESOP financing can also be used to make acquisitions,buy back publicly-traded stock, or for any other corporatepurpose.

The companies go for financing through ESOP as itprovides two way tax benefits. Firstly as the ESOPcontributions are tax deductible, thus the company wouldget the benefit of deducting interest as well as principalfrom taxes which in turn leads to reduced cost offinancing. Secondly is that the dividends paid on ESOP

stock passed through to employees or used to repay theESOP loan are tax deductible.

The company should invest in ESOPs as the employeesare the intellectual capital of the company.

At present ESOPs are mostly being offered as anaddendum to the salary package. So because of its

advantages many employees are opting for it but if itconstitutes a significant portion of their salary as is thetrend in US then they need to properly evaluate its prosand cons.


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DIFFERENT KINDS OF ESOP

ESOP can be a one-time plan or an ongoing scheme

depending upon the objectives that the company wants to

achieve. ESOPs can be in the form of ESOS (Employee

Stock Option Schemes), ESPP (Employee Stock Purchase

Plans), Compensation Plans, Incentive Plans, SAR/Phantom

ESOPs etc.

Employee Stock Option Scheme (ESOS) - Under this

scheme, the company grants an option to its employees to

acquire shares at a future date at a pre-determined price.

Eligible employees are free to acquire shares on vestingwithin the exercise period. Employees are free to dispose of

the shares subject to lock-in-period if any. Generally

exercise price is lower than the prevalent market price.

Employee Stock Purchase Plan (ESPP) - This is generally

used in listed companies, wherein the employees are given

the right to acquire shares of the company immediately, not

at a future date as in ESOS, at a price lower than the

prevailing market price. Shares issued by listed companies


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under ESPP will be subject to lock-in-period, as a result, the

employee cannot sell the shares and/or the employee has to

continue with the employer for a certain number of years.

Share Appreciation Rights (SAR)/ Phantom Shares - Under

this scheme, no shares are offered or allotted to the

employee. The employee is given the appreciation in the

value of shares between two specified dates as an incentive

or performance bonus, that is linked to the performance ofthe company as a whole, as reflected in its share value.


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REGULATORY FRAME WORK IN INDIA:

Companies Act, 1956:

As per section 2(15A) of Companies Act, 1956, employeesstock option means option given to the whole time directors,

officers or employees of a company, which give them the benefit

or right to purchase or subscribe at future date, the securities

offered by the company at predetermined price.

Further, as per section 79A, a company may issue sweat equity

shares of a class of shares already issued, if following conditions

are fulfilled:

The issue of sweat equity shares is authorized by a special

resolution passed by company in general meeting the

resolution specifies the number of shares, current market

price, consideration, if any, and the classes of directors oremployees to whom such shares are issued on date of issue

at least one year elapsed since the date on which company

was entitled to commence the business for companies

whose shares are listed in recognized stock exchange, it

should be in accordance with regulation made by SEBI for

other companies, in accordance with prescribed guidelines.


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Securities and Exchange Board of India (employee Stock Option

Scheme and Employee Stock Purchase Scheme) guidelines, 1999:

The companies whose shares are listed in any recognized stock

exchange in India may issue equity shares under the scheme of

ESOS or ESPS in accordance with these guidelines. This

guideline has been amended in 2004, 2008 and 2009. These

guidelines are dealt with at length in subsequent chapters.

Employee Stock Option Scheme and Employee Stock Purchase

Scheme Rules, 2002:

These rules have been notified by Central Government. These

Rules shall apply to any company which grants employees stock

options either under a scheme or otherwise.

Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003:

These Rules shall be applicable to issue of sweat equity shares

by all unlisted companies.

Guidance Note (A) 18 (issued 2005):

This is a guidance note on Accounting for Employee Share Based

Payments. It establishes financial accounting and reporting

principles for employees share based payments plan like ESOS,

ESPS and stock appreciation rights.


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SWEAT EQUITY

DEFINITION OF SWEAT EQUITY

Sweat equity is a term used to describe the contribution made to

a project by people who contribute their time and effort. It can be

contrasted with financialequitywhich is the money contributed

towards the project. It is used to refer to a form

ofcompensationbybusinessesto their owners or employees.

The term is sometimes used in partnership agreements where

one or more of the partners contributes no financial capital. In thecase of astartup company, employees might, uponincorporation,

receivestockorstock optionsin return for working for below-

market salaries (or in some cases no salary at all). The term can

also be used to describe the value added to real estate by owners

who make improvements by their own toil. The more labor applied

to the home, and the greater the resultant increase in value, the

more sweat equity that has been used.

Sweat equity is the effort made to enhance the value of property

by means of making improvements. Generally, the enhancements

must be done either by the property owner or by a buyer who is

interested in purchasing the property. The idea is to add to the

overall desirability of the property in some manner, while still

creating a financial advantage for either the owner or the buyer.
http://en.wikipedia.org/wiki/Ownership_equityhttp://en.wikipedia.org/wiki/Ownership_equityhttp://en.wikipedia.org/wiki/Ownership_equityhttp://en.wikipedia.org/wiki/Remunerationhttp://en.wikipedia.org/wiki/Remunerationhttp://en.wikipedia.org/wiki/Remunerationhttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Startup_companyhttp://en.wikipedia.org/wiki/Startup_companyhttp://en.wikipedia.org/wiki/Startup_companyhttp://en.wikipedia.org/wiki/Incorporation_(business)http://en.wikipedia.org/wiki/Incorporation_(business)http://en.wikipedia.org/wiki/Incorporation_(business)http://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Stock_optionhttp://en.wikipedia.org/wiki/Stock_optionhttp://en.wikipedia.org/wiki/Stock_optionhttp://en.wikipedia.org/wiki/Stock_optionhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Incorporation_(business)http://en.wikipedia.org/wiki/Startup_companyhttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Remunerationhttp://en.wikipedia.org/wiki/Ownership_equity


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Sebi Guidelines With Respect To Sweat Equity:

Sweat equity and Companies Act, 1956:

Issue of sweat equity shares is governed by the provisions of S.

79A of the Companies Act. Explanation II to the said Section

defines the expression sweat equity shares to mean equity

shares issued by the company to employees or directors at a

discount or for consideration other than cash for providing the

know-how or making available rights in the nature of intellectual

property rights or value additions, by whatever name called. It is,

therefore, necessary for the issue of sweat equity shares that theconcerned employee either provides the know-how, intellectual

property rights or other value additions to the company

Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003:

The Rules here provide the procedure to be followed by a

company issuing sweat equity shares for consideration other than

cash.

SEBI (Issue of Sweat Equity) Regulations, 2002:

The Companies whose shares are listed in any of the

recognised stock exchanges in India must fallow the Security and

Exchange Board of India (issue of Sweat equity) Regulations,

2002 over and above the requirements of Companies Act, 1956


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BENEFITS OF SWEAT EQUITY:

With availability of sweat equity programs, low-

income home buyers can easily make adequateinvestment towards their new home. This helps them

to avail low cost mortgages having comparativelylesser loan amount. Therefore, borrowers can pay off

the loan at reduced monthly payments.

Sweat equity helps home buyers with sufficient

amount to make their down payment. In most cases,it amounts to 10% or 15% of the sales price as the

down payment. This helps them to avoid paying for

private mortgage insurance premiums till the homeequity increases to 20% of the property value. Thishelps lenders offering mortgages recover monetary

loss in case the borrower cannot repay the entireloan.


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CRITERIA FOR JOINING SWEAT EQUITY

PROGRAMS.

Sweat equity programs are applicable to those who

reside in unhealthy or unsafe conditions or pay a

large sum as rent compared to their income.

They must be willing to put in several hours of labortowards the construction of the property.

The individuals requiring such programs must belegal residents for minimum 3 years in the statewhere they wish to buy the property.

The individuals must be working with an organizationfor at least 3 years in that particular state.

Candidates should have the ability to afford

mortgage payments. They should also not have largeamount of debt.

The programs fix a limit on employment generated

income and long term disability income, if any,

within a certain value and candidates of such

programs must fulfill the required limit


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ESOP VS. SWEAT EQUITY

Some of the significant differences between the two are:

Sweat Equity is grant of shares at discount or without monetaryconsiderations whereas ESOP/ESOS is grant of option topurchase share at predetermined price given to employees.

Sweat Equity can be issued to the promoters of the Companywhereas ESOS/ESOP cannot be issued to the promoters orpromoter group

Minimum lock in period of 3 years for Sweat Equity whereas nosuch lock in period for ESOP and lock in period of 1 year for

ESPS.


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CONCLUSION:

In view of the various rules and notifications both under theCompanies Act and under the Income-tax Act, a properreading and analysis of Companies Act, Income-tax Act andAccounting Standards / Guidance Note of ICAI needs to beundertaken in order to structure the schemes in a way that

maximum benefit, both to the employer and to the employeeis achieved.

Under the Companies Act, ESOP and SE are separatelydefined and considered separately in Section 81 and Section79A, respectively.

The Income-tax Act defines only the ESOP and is absolutelysilent on SE. However, on reading of Section 17(2), onewould notice that ESOP includes shares issued toemployees free of cost. Thus it can be concluded that underthe Income-tax Act, ESOP and SE are the same, thoughdistinguished under the Companies Act.


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INDEX

PARTICULARS SIGN1 introduction

2 Definition of ESOP

3 Different terms of ESOP

4 Key elements of ESOP

5 Advantages &Disadvantages of ESOP

6 Usage of ESOP

7 Different kind of ESOP

8 Regulatory framework in India

9 Definition of Sweat equity

10 Benefits of sweat equity

11 SEBI guidelines with respect to sweat equity

12 Criteria for joining sweat equity programs

13 ESOP v/s Sweat Equity

14 Conclusion

15 Bibliography


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Types of Employee Stock Options | eHow.com

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employee-stock-options.html#ixzz1AMEuuQEe
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