ESOP Buy Back in Indian Start-ups

Section 2(37) of Companies Act, 2013 defines “employees stock option” as ‘means, the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.’

Due to inter alia the Covid 19 pandemic, certain start-ups in India saw disrupted bottom-lines while some witnessed unprecedented growth, this has led to many new and complex legal structures being explored.

In India, the employee stock option (“ESOP”) buyback gained most traction in 2018 when Flipkart announced a 100% buyback option of vested ESOPs. Since then, many companies have exercised the ESOP buyback options including Oyo, Unacademy, Meesho, CarDekho, Razorpay, Swiggy, Byju’s, and now include start-ups like Slice, The MathCompany, Bizongo and the EdTech unicorn LEAD, have rewarded their employees via ESOP buybacks.

As majority of start-ups in the recent past are adopting the ESOP route to retain and compensate their employees; for any start-up, company and/or LLP registered in India, it is advisable that such a company should create an ESOP pool as soon as possible, post its incorporation, however it should definitely create an ESOP pool prior to any fundraise/investment in the Company.

Any ESOP scheme prepared should be custom drafted for the company keeping in mind its specific objectives, the fundamental parameters of the founder/promoter and the relevant laws applicable therein. It should also be kept in in mind that any ESOP buy back scheme that the company may propose, will ultimately take its origin from the ESOP policy of the company.

An ESOP buyback is a scheme extended by the company wherein, eligible employees are provided an option to sell their vested shares/options held by them, back to the Company at the proposed price, which is generally equivalent to the fair market price of the shares of the company. Such buybacks of ESOP’s allow the employees of the said company to monetise their holdings in the company at a higher price and participate in wealth creation for the company.

ESOP buyback can be due to varied objectives of companies, such as providing liquidity to its employees or company restocking its ESOP pool etc. Whilst earlier, ESOP’s were added as an option to the compensation package by start-ups to retain high-level employees, it has only been in the past 3-5 years that such employees have been able to realise the actual value of holding sweat equity in the company. The latest trend seems to have taken it another step further, now also providing a chance to the said employee to liquidate its holding in the company, through such buy backs and sharing the growth and success of the company.

Please note that the amount received by the employee through sale of ESOPs shares/options will be considered as an income and hence will be subject to relevant income tax laws.