Overview: A share option plan is commonly used by companies to attract, reward, and retain talent, typically their employees. It is commonly known as "ESOP" (Employee Share Option Plan). It allows eligible employees to buy a defined number of shares at a fixed price known as the exercise price. These employees will benefit from the company's increase in value by exercising their option to buy shares when the shares are trading at a price greater than the exercise price.
What is a share option?
A share option is not a share but a right to acquire shares when exercised. Share options are usually "vested" over time or upon fulfilling certain conditions (e.g. performance targets), meaning that the option holder can exercise the right and acquire shares in the company.
Steps to be followed for ESOP:
Step 1: Adopting a share option plan
Firstly, the company adopts a Share Option Plan that establishes the general rules under which the board will grant the options. The Share Option Plan typically sets out the purpose of the plan (e.g. to incentivise employees), who will be eligible to participate in the plan (e.g. employees of all levels or a certain level or above) and, most importantly, the overall size of the pool of shares that the option holders will be entitled to buy. The Share Option Plan also generally sets out how to grant an option, how to exercise an option granted, and what happens when the option holder leaves the company or dies.
You must note that a Share Option Plan only sets out the rules on how the options will operate; it does not give any right to any individuals participating in the plan.
Step 2: Granting options
Following the adoption of the Share Option Plan, the company may grant options to individuals by issuing Option Certificates. Each Option Certificate sets out the specific terms of grant for each individual, including the total number of shares to be purchased upon full exercise of the option, the exercise price, the exercise condition (if any), and the date (or dates) on which the option becomes exercisable (i.e. the vesting date (or dates if applicable)).
To help the option holder understand how to exercise his option, the company may use a Letter for Grant of Option as a cover letter for issuing the Option Certificate.
Step 3: Exercising share options
Once the option granted under the Option Certificate becomes exercisable, the option holder may exercise that right, i.e., to purchase the shares by giving a notice to exercise the option. The Letter for Grant of Option provides a standard form of this notice. The notice to exercise the option must enclose payment for purchasing the shares.
It is important to note that the Option Certificate also specifies the date until the option can be exercised. After this date, the option will lapse and can no longer be exercised (i.e. the option holder can no longer purchase shares at the specified exercise price).
If an option holder leaves the company, the part of the option that has not been exercised can no longer be exercised.
Step 4: Issue of shares upon exercise of option
Following a valid exercise of share options, the company secretary will issue and allot shares to the individual purchasing the shares, and that individual will become a company shareholder.
A Share Certificate will be issued to the individual as proof of ownership of the shares.
