Buy Back, ESOPs and Sweat Equity

Regulations
Presented By
Swapnil Churi (M910)
Vinay Deshmukh (M914)
Prina Doshi (M917)
Anagh Mahajan (M931)
Abhishek Mokal (M935)
Manali Pradhan (M943)
Gaurang Jardosh (P924)
Siddhi Prabhavale (P947)
Pankaj Warudkar (P960)
 Buy Back Shares

Section 77A, 77AA and 77B 

 Buy- Back of shares-Meaning
Take back the equity shares from market or

shareholders by paying cash and reduce equity shares

available in the share market. It is also known as a stock
repurchase
Cash is exchanged for a reduction in the number of

shares outstanding. The firm either retires the shares or

keeps them as treasury stock, available for re issuance
 Objectives
Increase promoters holding

Adjust or change the company’s capital structure quickly 

To increase EPS and net asset value per share

To improve the various performance parameters like

EPS,DPS, operating cash flow per share, etc.

To thwart the attempts of a hostile takeover.

To pay surplus cash not required by business

 EFFECTS OF BUYBACK
Effects On The Company

 Shareholding Pattern Changes

 Improvement in the Financial ratios of the company

Effects on the Shareholder

 Tax Benefits

 Higher Share Price

 Procedure for Buyback
Filing
Special/bo Public
Letter of with SEBI
ard announce
offer & stock
resolution ment
exchange

•Date of opening of the offer can’t be earlier than 7 days or later

than 30 days after the specified date
•Buy back offer shall remain open for a period of not less than
15 days and not more than 30 days.
•Company opting for buy back through the public offer or tender
offer shall open an escrow Account.
 Resources
Free reserves

Securities premium account

Proceeds of any shares or other specified securities

 Conditions 
Maximum Buy back can be upto 25% of total paid up

share capital and free reserves.

 Debt equity ratio should not be more than 2:1 after buy

back
 All the shares or other specified securities are fully paid up

  No default in complying with the provisions of filing of

Annual Return, Payment of Dividend, and form and

contents of Annual Accounts
 Disclosures in the explanatory statement
The notice of the meeting at which special resolution is proposed to

be passed shall be accompanied by an explanatory statement stating  

- a full & complete disclosure of all material facts
- the necessity for the buy-back
- the class of security intended to be purchased

under the buy-back

- the amount to be invested under the buy-back
- the time-limit for completion of buy-back
 Sources for the purchase of Buy Back
Existing security-holders

The open market through

(i)book building process (ii) stock exchanges 

Odd lots

 Purchasing the securities issued to employees of the

company 
 Filing of Declaration of solvency

Done using form 4A

Verified by an affidavit 

Signed by at least two directors of the company, one of

whom shall be the managing director

 Register of securities bought back
Company maintains a register of the securities/shares
bought with following particulars

a. Consideration paid for the securities bought-back

b. Date of cancellation of securities

c. Date of extinguishing & physically destroying of

securities
 Issue of further shares after Buy back
Buy Back Should be completed within 12 months

from the date of passing the special resolution or

Board resolution
Such a company can’t make any issue of the same kind

of securities 
Filing of return with regulator
File return in form 4C, with Registrar & SEBI, within

30 days of buy back completion

Unlisted company need not do so
Prohibition 
A company shall not directly or indirectly purchase its

own shares or other specified securities - 

(a) Through any subsidiary company including its own

subsidiary companies

(b) Through any investment company or group of

investment companies
CASE OF SUCCESSFUL BUYBACK
GLAXOSMITHKLINE Consumer Healthcare Ltd.
Sellers of Horlicks, Boost, Crocin, Iodex and many

others
Made an open offer to buyback during March 2005

Offered to buy 3.3 Mn

At Rs 370/Share, not exceeding 123 Cr in value

Represented 23.24% of free reserves

 REASONS FOR BUYBACK
Promoters holding would increase from 39.99% to
43.16%
Had excess reserves with no major expansion plans
Wanted to use its reserves instead of keeping it idle
Felt share was undervalued
FMCG industry in that period had limited growth
plans
Thus Britannia, Godrej and HUL all came with
buyback plans
 SUCCESS OF BUYBACK
Received more than double the required offers
(7.8 Mn)
Bought back using proportional acceptance
method

Pre Buy back Dec 04 Post Buy back Dec 05

Net Worth(Rs Lacs) 599,35.17 47511.18
Return on Net Worth 13.82% 22.55%
Earning Per share(Rs) 16.12 25.48
Book value Per share(Rs) 116.65 96.62
P/E 20.50 24
 CASE OF UNSUCCESSFUL BUYBACK
INDIAN RAYON
An AV Birla Group Company into the garment

business
Announced buyback in 1999

Buyback of 25% equity share capital

Price offered was in the range Rs 75-85

Intended cash outflow Rs 127-144 Cr

 REASONS FOR BUYBACK
To increase promoters stake from 21.5% to 28.7%

Working at below capacity and no major capex

planned
Wanted to add value to share holders by returning

capital to them
Cement business was hived off to Grasim

Buyback would give investors an exit route

 LIMITED SUCCESS OF BUYBACK
Could purchase only 11% of its outstanding shares as against

the 25% offered

Hiked the price on offer to Rs. 85

Market cap fell from 1397 Cr in 1999 to 455 Cr, 5 years later

Share price plunged from Rs. 207 to Rs. 67

Launched at wrong time- Co. was not doing well and

markets were crashing

 CONCLUSION
Not all buybacks are successful

The timing of the buyback is very crucial. If

company is not doing well then the buyback might not

succeed
Gives the market a signal that promoters believe in

the company
The demand supply dynamics go in favour of the

company
Employee Stock Option Scheme

Section 81 
 ESOPs - Definition
Section 2(15A): Employee Stock Option means

the option given to the whole time directors,

officers or employees of a company, which gives
such directors, officers or employees the benefit or
right to purchase or subscribe at a future date, the
securities offered by the company at a pre
determined price
 Objectives
Attracting critical skills
Employee feeling of ownership and commitment
Creating additional wealth for employees
A method to supplement social security benefits
To retain employees or groups apprehended of
high turnover
To enforce corporate governance
 Types of ESOPs

Employee Employee Share

Stock Option Stock Appreciation
Scheme Purchase Plan Rights (SAR)/
(ESOS) (ESPP) Phantom Shares
●
This is generally used in
●
No shares are offered or
●
Option to employees to allotted to the employee
acquire shares on future listed companies
●
Employees are given the
●
Employee is given the
date at predetermined rate appreciation in the value of
right to acquire shares of
●
Employees are free to shares between two
the company immediately,
dispose of the shares specified dates as an
not at a future date
subject to lock-in-period incentive or performance
●
Shares issued will be
if any bonus
subject to lock-in-period It is linked to the
Generally exercise price
●
●
●
Generally exercise price is performance of the company
is lower than the lower than the prevalent as a whole, as reflected in its
prevalent market price. market price share value
Flexibilities in application of ESOPs
Stock Appreciation Rights: employees are given "Rights" to a particular number of shares

at the market price on the date of allotment of Rights. Shares are physically not
transferred in the names of employees nor do they give any money to buy the shares
These rights are redeemable in instalments at regular intervals at the market price

prevailing on the date of the redemption. Employees are given the appreciation benefit.
Options to employees to buy shares at the average of the last six months market price and

offer soft loans from the company to buy these shares, These options are given in
instalments at intervals of one or two years. Thus, there is no lock in period
Offer the option of warrants which are converted into shares at a fixed price at the option

of the employee. In this, the warrants are converted into shares at far less price than the
market and this makes the scheme attractive.
 Eligibility
He should be an ‘Employee’
As per the definition of ‘Employee’ given in the SEBI
guidelines, it includes directors and whole time directors
An employee who is a promoter or belongs to the promoter
group is not eligible to participate in ESOP
Recently the SEBI has permitted the nominee directors
appointed by the financial institutions, banks, etc., on the
board of directors of the assisted companies to participate in
ESOP subject to the provisions of the contract or agreement
entered in to between such director and the nominating
institution.
 Disqualification
 An employee who is a promoter or belongs to promoter
group
 A director who either by himself or through his relative or
through any body corporate, directly or indirectly holds
more than 10% of the outstanding equity shares of the
company shall not be eligible to participate in the ESOS.
(Promoter is a person(s)
- who is in over all control of the company
- who is instrumental in the formation of the company
- is named so in the offer document
Promoter group includes immediate relatives of the promoter i.e. spouse,
parent, brother, sister or child of the person or of the spouse)
 Various Stages in ESOP Process
Vesting
Grant process by which the
Issue of stock employee gets the
options to right to apply for and
employees under be issued shares of the
company under the
ESOP options granted to him
Employees may Upon vesting, the
be required to employee gets an
pay upfront unfettered right to
apply for the issue of
amount shares
Vesting Period
the period during
which the vesting of
the options granted to
an employee takes
place
The SEBI guidelines
provide that the
vesting period shall
not be less than one
year from the date of
grant of options
 Stages – Cntd..

Exercise Period Exercise

Vesting Percentage the time period after making of an
refers to that vesting within application to the
portion of the which the employee company by an
total options should exercise his employee together
granted, which right to apply for with the requisite
an employee is the shares amount, for issue
eligible to Failing to do this, of shares against
the vested options the options
exercise
will lapse already vested
 ESOPs and Unlisted Companies
Issues Related To Unlisted Company’s ESOP Scheme
The main issue regarding the ESOP scheme in an unlisted
company is that how does the employee make money on his
shares?
For this some sort of a liquidity event is needed. Liquidity
events could include:
 Initial Public Offer
 Acquisition
 Equity investment
 Buyback by the company
 Purchase by the promoters/founders
till shares are issued to him on exercise of the option

 SEBI Reform committee recommended that ESOP shares

issued by an unlisted company may be allowed to get listed
after the IPO subject to fulfilment of the following
requirements:
 Ratification of the resolution passed for issuance of ESOP
 Disclosures in the offer document
 ESOPs and Listed Companies
 The procedure for formulating an ESOP scheme in a listed company
should be in accordance with the guidelines of SEBI
 SEBI (Employee Stock Option Scheme And Employee Stock Purchase
Scheme) Guidelines, 1999 regulates the ESOP in Listed Companies.
 Compensation Committee
No ESOP can be offered by a listed company unless a Compensation
Committee is constituted
Committee consist of majority of independent directors
 Duties:
 administer and supervise the scheme
 formulate the detailed terms and conditions of the scheme
 frame policies and system to ensure that there is no violation of SEBI (Insider
Trading) Regulations,1992 and SEBI (Prohibition of Fraudulent and Unfair
Trade Practices) Regulation, 1995
 Shareholders’ Approval
 By way of Special Resolution in a general meeting
 A separate resolution in general meeting is required in case of grant of
option
• To a subsidiary or a holding company
• To an identified employees, during any one year, equals to or exceed 1% of the
issued capital of the company at the time of grant of option.
The next steps are:
• Exercise of Option
• Allotment of Shares
• Sale of Shares
• Listing of ESOP

• Shares arising out of ESOP shall be listed immediately upon exercise of option,
in a recognized stock exchange where the securities of the company are listed.
 ESOP Procedure - Flowchart
Consideration of ESOP Consideration of ESOP
Drafting of Scheme by Board &
proposing constitution of
Scheme in EGM &
authorisation for
ESOP Scheme ‘Compensation Committee’
(CC) Constitution of CC.

Communicate – Meeting of CC –
determination of eligibility
Grant of options criteria, exercise price,
to Employees vesting Period, etc.

Acceptance Communicate – Employees exercising

options – forwarding
of Grant Vesting period application to CC

Hold BM for
Convey
allotment of
allotment to CC
Shares

Intimating allotment Entry into

Reporting to: ROC
to concerned Register of RBI, if applicable
Employee Members
 ESOPs

Advantage Disadvanta
s ges
●
Stock markets are highly volatile
●
Awareness of company ●
The difference between the ‘fair value’
success and the discounted ‘exercise price’ has
to be treated as employee compensation
●
Employee commitment and and it has to be debited to P&L account
satisfaction ●
lock-in-period leads to blocking of
funds.
●
Spurs change ●
ESOP leads to dilution in the
●
Heightened decision making shareholding percentage of other
●
Encourages reengineering shareholders including the promoter
group.
 Successful Implementation
Infosys ESOP Plan
Under the plan, 600000 warrants were issued to the Infosys
Tech Ltd employee trust in Sept. 1994
Warrants to be held in trust and transferred to selected
employees form time to time
Warrants were issued at Rs.0.50 each
Entitled the holder to be issued one equity share of par value
of Rs. 5 each at a price of Rs.50
Lock-in period of five years form the date of issue.
All warrants were converted into shares by Sept. 1999
Case: ESOPs for Independent & Nominee
Directors

Mr. Kranti Sinha Obtained L&T shares under ESOPs

According to SEBI guidelines, ESOPs are not meant for
Independent Directors & Nominee Directors
It is morally & ethically not correct
Alternate ways to reward nominee directors
This is the first instance where an LIC nominee-director
has acted against the instruction of its employer and
accepted ESOPs.
This opened the floodgates of similar complaints
Case: Sale of shares under ESOPs to other
Company

Dalmia group promoted firm GHCL Employees Stock

Option Trust alleged mismanagement of its funds
during transaction of 2,000,000 shares under ESOPs
Trust paid Rs. 10.48 crores as demanded
But shares were not transferred
IIFL sold those shares to clear dues
As per SEBI guidelines, selling shares to other
companies to clear dues is prohibited
IIFL sold 870,000 shares in 2008
Sweat Equity

Section 79A
 Definition
Equity acquired by a company's executives on
favourable terms, to reflect the value the executives
have added and will continue to add to the company.
Extra percentage of a firm's common stock (ordinary
shares) allocated to the senior executives (over and
above their current shareholdings) as an additional
motivation for continuing hard work for the firm's
success.
The equity that is created in a company or some other
asset as a direct result of hard work by the owner(s).
 To Whom Sweat Equity Could Be Issued
 Sweat equity shares by definition could be issued only to the
‘employees or directors’ of the company incorporated under the
Companies Act, 1956

 It could also be issued to the directors or employees of the foreign

subsidiary of an Indian incorporated company a foreign
subsidiary is incorporated outside India

 While the section mentions only ‘employees or directors’ the SEBI

regulations also mentions issue of sweat equity to ‘promoters’.
 The Consideration for Issue of Sweat Equity

• The allotment of sweat equity should be ‘at a discount’ or

‘consideration otherwise than cash’.

• Sweat equity could be issued in consideration of providing know-how

or making available rights in the nature of intellectual property or for
value addition contributed by such employee or director.
Provisions In Companies Act On Sweat Equity
 Section 79A of the Companies Act, 1956 authorizes the issue of sweat
equity shares subject to certain conditions.
 Section 79A:
(1) Notwithstanding anything contained in section 79, a company may issue sweat equity
shares of a class of shares already issued if the following conditions are fulfilled,
namely-
a. the issue of sweat equity shares is authorized by a special resolution passed
by the company in the general meeting;
b. the resolution specifies the number of shares, current market price,
consideration, if any, and the class or classes of directors or employees to
whom such equity shares are to be issued;
c. not less than one year has, at the date of the issue, elapsed since the date on
which the company was entitled to commence business;
d. the sweat equity shares of a company, whose equity shares are listed on a
recognized stock exchange, are issued in accordance with the regulations
made by the SEBI in this behalf:
Section 79A Contd..
 Provided that in the case of a company whose equity shares are not
listed on any recognized stock exchange, the sweat equity shares are
issued in accordance with the guidelines as may be prescribed.

(2) All the limitations, restrictions and provisions relating to equity shares
shall be applicable to such sweat equity shares issued under sub-section
(1).
 Price at Which Sweat Equity Could be Offered
The SEBI regulations state that the price shall not be less than the higher of the
following-

 The average of the weekly high and low of the closing prices of the related
equity shares during last six months preceding the relevant date;
OR
 The average of the weekly high and low f the closing prices of the related
equity shares during the two weeks preceding the relevant date.

The regulations for unlisted companies provide that the price should be “fair
price calculated by an independent valuer” and separate consideration is
given for issue of sweat equity in case of ‘consideration other than cash’
Class Of Shares Which Could Be Issued As Sweat Equity

Sweat equity shares can issued only of a class of shares

already issued

It must be only an ‘equity’ shares and not a ‘preference

share’
 General Principles In Issue Of Sweat Equity

1. The issue shall be authorized by a special resolution.

2. The issue of sweat equity shares by a listed company shall be in accordance with
the SEBI (Issue of Sweat Equity shares) Regulations, 2002.

3. In case of an unlisted company, issue of sweat equity shares shall be subject to

Unlisted Companies (Issue of Sweat Equity shares) Rules, 2003.

4. Sweat equity shares is treated as any ordinary equity shares issued by the
company in all respects except in certain cases the issue is for consideration other
than cash.

5. The voting rights and rights as to dividend etc. will be pari passu with the existing
class of equity shares.

6. In terms f section 77A (5) (d) it is possible for the company to buy back sweat
equity issued to employees of the company pursuant, inter alia, to a scheme of
sweat equity.
 Sweat Equity Shares And Unlisted Companies

 Under The Proviso To Clause (D) To Sub-section (1) Of Section 79A, It Is

Provided That In The Case Of A Company Whose Equity Shares Are Not Listed
On Any Recognized Stock Exchange, The Sweat Equity Shares Should Be
Issued In Accordance With The Guidelines As May Be Prescribed.
 From 2003, Rules for Unlisted Companies (Issue Of Sweat Equity Shares)
a. To Whom Sweat Equity Could Be Issued
b. Price At Which Sweat Equity Could Be Issued
c. Authorisation By Special Resolution
d. Restriction on Issue of Sweat Equity Shares
 for more than 15% of total paid up equity share capital in a year or
 shares of the value of 5 crores of rupees,

e. Register of Shares
f. Lock-in of Sweat Equity Shares
g. Certificate from Auditors
 Sweat Equity Shares And Listed Companies
 79A (1)(d), sweat equity shares in cases of companies listed on a recognized
stock exchange must be in accordance with the regulations made by the SEBI.

 SEBI has issued the SEBI (Issue of Sweat Equity Shares) Regulations, 2002,
laying down the guidelines for the issue of sweat equity shares by listed
companies.
a. Applicability
b. To Whom Sweat Equity Could Be Issued
c. Pricing of Sweat Equity Shares
d. Valuation of Intellectual Property
e. Authorisation By Special Resolution
f. Promoters & Sweat Equity Shares
 It is not clear whether sweat equity could be issued to ‘promoters’ as defined in these
Regulations, unless such promoter is also either an employee or a director.
 Promoters could also be shareholders.
 in case of issue of sweat equity to promoters both the requirement of special resolution (at
which the promoter also could vote) as also an ordinary resolution (wherein the promoter do
not participate) shall be passed.
 In addition the resolution could be passed by postal ballot .
ISSUE OF SWEAT EQUITY SHARES TO PROMOTERS- SOME ISSUES
 Sweat Equity

Advantages Disadvantages

●
Highly efficacious in extracting the
employees efficiency
●
Promotional in nature as it a means of
receiving shares without spending money
●
Cost efficient for company as it can save
on the employee’s to be given salary
●
Receiving of sweat equity is a long term
investment
●
More income to the employees
●
Receiving the right to participate in the
company’s management for employees
●
More of dilution of power as share is being issued
●
Can lead to inefficiency of employees when the
feeling of being in power creeps in
●
Can also lead to irregularity in income for the
employees
●
Consideration in the nature of share can be heavy
on otherwise low income employees
●
During recession or liquidation, the sweat equity
share holders may face larger troubles as their
effort go non-benefitted to them.
●
Excessive issue of sweat equity shares can also
lead to overcapitalisation which in turn would be
heavy for the company
 IPL - Case
 The Indian Premier League (“IPL”) has been mired in controversies the Rendezvous
Consortium winning the Kochi IPL franchise for $ 333 million.

 The IPL chairman and commissioner Lalit Modi revealed the shareholder ownership of
the Kochi franchisee last week.

 Mr. Modi claimed that Rendezvous Sports World Pvt. Ltd., a member of the consortium,
had received 25% free equity, of which Ms. Sunanda Pushkar reportedly received 18%,
valued at nearly Rs 70 crore.

 This became a political issue for Member of Parliament Shashi Tharoor due to his
relationship with Ms. Pushkar and Mr. Tharoor subsequently resigned as a cabinet
minister.

 A critical question became Ms. Pushkar’s sweat equity. Mr. Tharoor stated that
Rendezvous had issued sweat equity to its associates, ie. Ms. Pushkar in lieu of a salary
as this is “common practice across the world for start up ventures”.
 Current Debate/Multiple Discrepancies
 Sweat equity shares can only be issued a year after a company has been incorporated; it
has not been a year since Rendezvous has been incorporated.

 Sweat equity shares may not exceed 15% of the share capital and may not exceed Rs. 5
crores in value; Ms. Pushkar appears to have received 18% equity at a valuation of Rs. 70
crore

 In order to go above the shareholding percentage and valuation ceilings, prior government
approval must be obtained; there appears to be no prior government approval.
 
 Issue of sweat equity needs to be passed by a special resolution; no confirmation that
such a resolution was passed.
 
 In addition, pursuant to section 77A of the Companies Act, there are specific regulations
regarding the buyback of shares including where the company must get the resources for
the buy back and objectives, conditions and procedures for the buy back of shares. All of
these provisions must be complied with in order for the company to buy back Ms.
Pushkar’s shares.
 Sweat Equity
 There is a long debate going on in relation of the issuance
of sweat equity by the listed and unlisted companies

 At present the issuance by type of companies are governed

by different regulations

 It has been advised that to bring the uniformity in the law

and to make it simpler for the companies, both of them
should be governed by similar laws
Thank You