Decoding ESOPs & Equity Management

The Articles of Association serve as a document detailing a company's operational rules and its fundamental objectives. This document delineates how tasks are executed within the organization, encompassing director appointments and financial record management.

It also provides a comprehensive framework for the company's managerial and administrative setup. The document often includes details on shareholder rights, director appointments, and the protocols for company-wide meetings.

Anti-dilution is a mechanism used to protect existing investors' ownership percentage in a company when new shares are issued, which might otherwise decrease the value of their holdings. It's designed to ensure that the existing shareholders don’t suffer a reduction in their ownership due to subsequent rounds of financing at a lower valuation.

There are a few ways anti-dilution protection can occur:

Full Ratchet: This method provides the most protection to existing investors. If new shares are issued at a price lower than what the previous investors paid, the existing investors' shares are adjusted downward to match the new, lower price.

Weighted Average: This method is more commonly used and less harsh than the full ratchet. It takes into account both the price and the number of shares issued in the new round and adjusts the existing investors' shares based on a weighted average of the old and new prices.

Anti-dilution provisions are typically outlined in investment contracts, particularly in preferred stock agreements. They're designed to maintain fairness and protect early investors from the potential negative impact of future fundraising rounds that may undervalue the company.

Authorized capital is the maximum amount of share capital that a company is allowed to issue at the time of its incorporation. Also called the nominal capital or registered capital, this is decided by the shareholder and defined in the memorandum of association (MOA) or its article of incorporation.

If one wants to update the authorized capital they’ll have to pass a resolution during the shareholder’s meeting and update it with the ROC. This is different from paid-up capital as paid-up capital is the money for which shares have been issued and payment has been made.

For simpler understanding, it is like the funding limit on your credit card. It tells one (including the potential investors) how much money you’re allowed by selling shares in your business. The only difference is that here you only set the limit based on your capital needs in the future. In case you see a room to grow, all you need to do is increase the credit limit by taking the approval of shareholders and paying an additional fee to the Registrar of Companies.

It refer to the approval given by shareholders during decision-making processes in a company. Shareholders cast these votes to express their support or agreement with proposals presented in shareholder meetings. Each share typically grants one vote, and the cumulative affirmative votes influence the outcomes of significant decisions, such as mergers, acquisitions, or changes to corporate policies. Specific requirements, outlined in company bylaws or applicable laws, may dictate the percentage of affirmative votes needed for certain decisions to be approved. Understanding these rules is crucial for shareholders, as it directly impacts their ability to shape the direction and governance of the company in which they hold equity.

A bonus issue, also known as a scrip issue or capitalization issue, is another way for companies to reward their existing shareholders by offering them free additional shares. The company decides to create a certain number of new shares and allocates them proportionally to the existing shareholders. This means, that for every x shares a shareholder already owns, they receive y free bonus shares.

The difference with the rights issue is that shareholders don't need to pay any money to receive bonus shares. They are rewarded for their existing investment with additional ownership in the company. These boost market confidence by signaling to the investors that the company is doing well and reward shareholders for their support and investment.

Buyback is a process when a company opts to repurchase its own shares. It typically involves acquiring shares at a price exceeding the current market value. This repurchase can occur either directly from existing shareholders or, if the company is publicly listed, from the open market.

Companies undertake share buybacks for various strategic reasons. One primary motive is to regulate the valuation of their shares. By reducing the overall number of shares available in the market, the company aims to boost the value of the remaining shares. This move also serves to prevent potential shareholders from accumulating a majority stake in the company.

It's important to note that there are constraints on the number of shares a company can repurchase within a financial year. Furthermore, only companies possessing ample cash, either in free reserves or their securities premium account, are eligible to engage in share buybacks.

Cliff is the time period during which the ESOP holder cannot vest their options to gain full ownership of their shares. As per the Indian law, the minimum cliff period is one year.

Companies usually set a cliff period for their options so as to incentivize employees to stay with the company for a fixed period of time.

Once the cliff period is over, the employee has the right to receive the allocated shares. However, if the employee decides to leave the company before the cliff period expires, they receive no shares."

A change in control takes place when the majority ownership of shares is transferred to different shareholders. The decision-making power in a company is typically held by the owners of its shares. Consequently, when there is a shift in ownership, there is a corresponding transfer of decision-making authority. Such changes in control can significantly impact the direction and management of the company. Besides, this change often occurs when a significant point, such as 50% ownership, is reached, signifying a substantial change in the balance of decision-making influence within the company.

Condition Precedent refers to a specified event or circumstance that must occur before certain rights or obligations take effect. It often involves prerequisites such as a minimum tenure or achievement of performance targets for employees to become eligible for stock options or other benefits within the plan.

Condition Subsequent refers to a condition that must be satisfied after a specific event or timeframe, influencing the execution of certain provisions. It could involve vesting requirements or performance benchmarks that, once met, trigger the allocation of employee stock options.

Co-Sale rights, also known as "Tap Along rights", a contractual agreement granted to minority shareholders, often financial investors in a start-up, enabling them to sell a proportion of their shares to a buyer interested in purchasing the majority shareholders' shares, typically the founders. This provision safeguards the interests of minority shareholders and provides them with liquidity. The specifics of when and how this right can be exercised are outlined in the shareholders' agreements or the Articles of Association of the company.

Employee stock option plans come with a designated vesting period. This vesting period is tied to the criteria of vesting which may be time or performance. However, despite these conditions, there is a possibility that an event may lead to a withdrawal of the terms of the vesting schedule

If this vesting period is nullified based on more than a single event or factor, it is called a double trigger.

Examples include:

1. Change of control due to a merger, acquisition, or sale of the company and involuntary employment termination
2. Performance-based vesting and change of control

Dilution happens when the earnings per share and book value per share decrease because more shares are issued. This occurs when convertible securities are converted, or warrants or employee stock options are exercised. With an increase in the number of shares available, each current stockholder owns a smaller portion of the company, which dilutes the value of each share.

Differential voting rights (DVRs) confer additional privileges upon certain shareholders, determined by their preferences. These shareholders have the flexibility to opt for an increase or decrease in their voting influence. It's essential to note that the total DVR shares cannot exceed 25% of the overall issued share capital.

In practice, companies often issue shares with DVR to safeguard control and shape decision-making. This strategy empowers founders or pivotal stakeholders to uphold strategic leadership, even in the face of ownership dilution.

Drag-along rights, commonly a part of shareholders' agreements or investment contracts, empower majority shareholders to compel minority shareholders to participate in the sale of a company, triggered by events like a third-party acquisition offer.

When majority shareholders decide to sell 100% to a buyer, the drag-along provision allows them to force minority shareholders to sell their shares under the same terms and conditions. This mechanism ensures a unified sale of the entire company, streamlining the process and preventing minority shareholders from obstructing a sale deemed advantageous by the majority. While these provisions aim for efficiency, negotiations often include safeguards to protect minority shareholders, ensuring fair treatment in the sale process. Understanding and carefully negotiating drag-along rights is crucial for shareholders to safeguard their interests and align the provisions with their expectations.

Exercise’ in ESOPs is the act of employees using their right to purchase company shares at a pre-established price.

Once the vesting period is over and the employee has gained the right to own company shares, the employee can exercise and convert their optios into shares to earn a profit from the company’s increase in value over time.

So if the employee intends to buy the shares, he/she may submit the exercise letter to the board of directors, post which his shares will be allotted.

Upon receiving options in a company, employees are provided with a corresponding grant letter that states the period within which the employee has the right to convert his options into company shares.

This pre-specified exercise period is when the employee must exercise his options and acquire company shares. If not exercised during this timeframe, the options automatically lapse.

An Employee Stock Ownership Plan Trust is an entity established by companies to hold shares for the purpose of the ESOP program and /or to hold shares on behalf of eligible employees participating in the ESOP program. The trust manages the allocation and distribution of shares, typically as part of an employee retirement benefit program.

In India, Company law prohibits firms from trading their own shares, except when held by an ESOP trust or an employee welfare trust. This exception has led to the rise of ESOP trust within the ESOP framework.

The Employee Stock Purchase Plan (ESPP) is a valuable benefit companies provide, allowing employees to purchase their employer's stock at a discounted rate. Typically offered by large or public corporations, these plans pool together employee contributions to make substantial investments in the company. This stock purchase signifies the employees' financial stake and grants them a partial ownership interest. Engaging in an ESPP aligns the employee's interests with the company's success, fostering a sense of participation in its achievements.

Founder vesting is a mechanism when a founder earns the right to purchase the company shares based on their performance and dedication to the company. Similar to regular employees, founders can exercise their options only upon meeting specific vesting criteria outlined in the founder's agreement.

The conditions of founder vesting are explicitly defined in the founder's agreement. Additionally, in the event that one or more co-founders depart, the company retains the option to repurchase their equity.

This arrangement serves two key purposes. Firstly, it incentivizes co-founders to remain dedicated to the company over the long term. Secondly, it safeguards the company's interests in case of a co-founder's departure.

FMV, or Fair Market Value, is the reasonable valuation at which a company’s options may be traded in the market.

It is the price at which the willing buyer will pay and the willing seller would be content to sell at. This ensures a fair and mutually beneficial exchange between the share buyer and the seller.

It refers to an anti-dilution provision aiming to protect early investors. In a funding round where new shares are issued at a lower price than what earlier investors paid, the full ratchet provision adjusts the conversion price of existing investors' securities downward to the new, lower price. This adjustment allows early investors to maintain their ownership percentage by acquiring more shares at a reduced cost, mitigating the impact of dilution. While it serves to protect early investors, the full ratchet may be perceived differently by founders and later investors, potentially influencing discussions on ownership distribution. However, it's worth noting that various anti-dilution mechanisms, including weighted average ratchets, are available, and their choice depends on negotiations and the specific dynamics of each financing agreement.

In the money' in ESOPs means the stock option's current market price is higher than the option's exercise (strike) price. This situation is favorable for the employee, as exercising the option allows them to buy shares at a lower price than the current market value, resulting in an immediate profit.

For a call option to be considered in the money, the option holder can purchase the security at a price below its current market value. And, an in-the-money put option allows the option holder to sell the security at a price higher than its current market value.

These are rights granted to employees to access, inquire, and receive crucial company information, including details about the company's financial performance and annual reports. This drives transparency, enabling ESOP participants to make informed decisions about their stock ownership.

Lock-in period is a specified time frame wherein the ESOP holders cannot sell or transfer their allocated company shares.

This restriction helps encourage the long-term commitment and interest of the employees. With this, there is a better possibility of employees waiting for the lock-in period to expire and gaining financially from their ESOP shares.

A liquidation preference determines the priority and amount of payment for stakeholders in the event of a company's liquidation. Typically, investors or preferred shareholders are granted the foremost position for repayment, holding the highest liquidation preference over common stock and debt holders. This practice is prevalent in venture capital agreements.

The Management Share Option Plan (MSOP) is a compensation strategy that enables a company's management team to purchase shares in the company at a predetermined price within a specified timeframe. This plan is designed to align the interests of management with those of shareholders, encouraging executives to contribute to the company's long-term success.

Typically, MSOPs grant managers the option to buy shares at a fixed price, known as the exercise price, which is often set below the market value at the time of the grant. As the company's stock value increases over time, managers can exercise their options, realizing a potential profit and further linking their financial incentives to the company's performance. As executives benefit from the company's stock appreciation, MSOPs play a significant role in shaping the capital structure and promoting sustained organizational success.

A Memorandum of Association (MOA) is a legal document prepared during the establishment and incorporating of a limited company. Its purpose is to define the company's connections with its shareholders. Publicly available, the MOA outlines critical details such as the company's name, registered office address, shareholder identities, and the allocation of shares.

It also defines the company's purpose and powers, helping stakeholders understand its scope of operations and limitations. Any changes to the MOA require approval through legal procedures and, in some jurisdictions, shareholder consent or approval by a regulatory body.

Merchant Banks are financial institutions that provide a range of services like Corporate Finance, Underwriting, Advisory services, Asset Management, International Trade and Finance, Private Equity & Venture capital, Risk Management, etc. Unlike traditional commercial banks, merchant banks primarily deal with large corporations and governments rather than individual consumers.

They act as intermediaries between investors and companies to provide expertise, access to markets, and risk management, creating a win-win situation for both parties.

Option grant is a form of compensation offered to employees or directors that grants the right to purchase a specific quantity of company shares at a predetermined price, known as the "strike price," within a defined timeframe. This serves as an incentive, aligning the interests of recipients with those of the company's shareholders. During the option period, the employee can buy shares at the strike price, set either at the market value or higher/lower at the company's discretion.

The objective of an option grant is to align the interests of employees with the company's performance, providing them with the opportunity to benefit financially as the company's stock value increases.

The Employee Stock Option Plan (ESOP) or Employee Stock Ownership Plan offers employees a valuable benefit: the opportunity to own shares within the company. These shares are acquired at a price below the market value, essentially at a discounted rate.

ESOP serves the purpose of fostering a more substantial commitment from employees towards the company. It not only incentivizes long-term dedication but also encourages a sense of ownership among employees towards the organization. To implement ESOP, employers must adhere to specific Acts and regulations outlined in the Companies Act when granting these plans to their employees.

An option pool comprises shares reserved for the employees of a private organization. It serves as a means to entice talented professionals to join a startup; if these employees contribute to the company's success and it goes public, they receive compensation in the form of stock. Typically, early-stage employees receive a larger percentage of the option pool compared to those who join the startup at a later stage.

The pre-money valuation is the company's worth before it goes public listing or secures external investments like funding or financing. Investors often leverage this valuation to gauge its value before committing funds. While commonly assessed by professional investors like venture capitalists (VCs) or angel investors, every founder must understand, irrespective of their current pursuit of investment opportunities.

The post-money valuation represents the estimated value of a company outside external funding or capital injections into its balance sheet. It specifically denotes the approximate market worth attributed to a startup following a round of funding from venture capitalists or angel investors. Before these funds are factored in, valuations are referred to as pre-money valuations. The post-money valuation equals the pre-money valuation plus the new equity from external investors.

Paid-up capital is the amount of money for which shares of the company have been issued and the payment has been made for these shares. It is the real money you have from selling shares, which you can use to build and grow your business – It is not borrowed money i.e. loans which you would need to repay.

Understanding the paid-up capital is especially important while calculating the equity holdings of shareholders, issue or recall or buyback or split of shares, and cases of capital alteration.

The image you want to start a lemonade stand with $100 dollars for 100 glasses of lemonade priced at $1. So, your authorized capital (the maximum you can make) is $100.

Now, let's say you've actually made and sold 50 glasses of lemonade, collecting $50 from your friends who bought them. That $50 is your paid-up capital - the real money you've received from selling your juice. So, paid-up capital is like the cash you've actually got in your hands from selling part of the lemonade you're authorized to make. It's not the full potential lemonade money, just the part that's already sold and paid for.

A private placement is a way for companies to raise capital by selling securities (like stocks or bonds) to a limited pool of chosen investors, rather than offering them to the public on a public exchange. To take a simpler example, it's like selling shares of your lemonade stand only to your friends and family, instead of setting up a booth at a town fair.

In such scenarios, individuals or institutions that meet certain income or net worth requirements are only permitted. To do this you’ll need to identify investors, submit valuation reports, pass a special resolution with the board along with preparing and circulate a Private Placement Offer Letter (PAS-4) detailing the offer to eligible investors within 30 days of Board approval. After receiving the subscription allotments of securities to eligible investors within 60 days of receiving the application money.

Since it is for targeted investors it has fewer regulations and can help maintain better ownership control as compared to public offerings. However, the drawbacks are having limited liquidity, higher risk, and less information for private companies to access information accurately.

Partially paid shares refer to company shares that have been issued to investors but are not fully paid for upfront. Instead, investors contribute a portion of the share value, and the remaining amount is payable over a specified period. This approach allows investors to acquire ownership of the company gradually. This helps companies raise funds quickly without waiting for full payment from investors and enables investors to pay for shares in installments, easing financial burden.

It’s a Latin term meaning "equal footing," employed to describe scenarios where multiple entities, such as assets, securities, creditors, or obligations, are managed without any preferential treatment. In the context of bankruptcy proceedings, the principle of pari-passu exists when the court treats all creditors equally. This implies that, upon reaching a verdict, the trustee disburses repayment to all creditors in the same proportion, ensuring fairness and impartiality.

This concept extends to various financial instruments, including loans and bonds. Within these instruments, specific clauses are often incorporated to enforce the equal treatment of similar financial products. These clauses play a crucial role in maintaining fairness, transparency, and consistency in financial transactions by preventing the elevation of one class of stakeholders over another

It is a Latin term that means "proportion" or "according to a specific rate or ratio.", implies that each investor receives a share of the distribution proportional to their investment or ownership stake. This ensures equal treatment among investors based on their proportional contribution to the fund.

The formula for calculating a pro-rata share is:

Pro Rata Share = Individual Investment/Total Investments × Total Distribution

Where:

Pro Rata Share is the amount an individual investor is entitled to receive.
Individual Investment is the amount of money the individual investor contributed.
Total Investments is the sum of all investments in the fund.
Total Distribution is the total amount being distributed among the investors.
This formula ensures that each investor receives a distribution proportionate to their initial investment, maintaining fairness and equity in fund distributions.

Reverse Vesting concept was introduced to safeguard the interest of the early stage investors or other co-founders in the event any of the founder/co-founder decides to leave the startup or company.

Under this arrangement, the departing founder must relinquish all or a portion of their equity in the company and transfer it to the remaining co-founders or the newly appointed personnel.

The introduction of reverse vesting also serves to safeguard the interests when new options are granted to incoming personnel.

Restricted stock in ESOPs refers to company shares granted to employees, subject to certain conditions. These conditions may include a vesting period or performance milestones.

During the restriction period, employees typically cannot sell or transfer the shares. Once the conditions are met, the restrictions lift, allowing employees to fully own and potentially sell the stock

A registered valuer is a professional who is officially recognized and authorized to conduct valuations of assets, properties, businesses, or other financial instruments. These individuals typically have specialized knowledge and expertise in assessing the value of various assets based on factors such as market conditions, financial performance, and industry trends.

Registered valuers play a crucial role in providing independent and unbiased assessments of the value of assets – they protect stakeholders from misrepresentation and unfair pricing. According to The Companies Act, 2013 a valuation issues by a registered valuer is necessary in case share issues, mergers, acquisitions, restructuring, or amalgamations

A rights issue , also known as a Rights offering, is a way for companies to raise additional capital from their existing shareholders by offering them the right to purchase new shares at a discounted price. It's like giving your loyal customers first dibs on a limited-edition product at a special price.

Each shareholder receives a certain number of "rights" based on their existing shareholding. The number of rights is proportional to the number of shares they already own. Each “right” gives the shareholder a new share at a predetermined price usually lower than the current market price.

The benefit of this is that companies can raise capital without debt, they can retain existing shareholders, and strengthen their ownership structure.

Reserved matters refer to key decisions exclusively retained by the company's board, such as alterations to the plan, granting equity, or changes in control. For this, there are clauses in the shareholder’s agreement defining the control of activities within the company.

The Right of First Refusal (ROFR) , also called the first right of refusal, is a contractual provision granting a specific party the opportunity to engage in a business transaction with an individual or company before any other potential buyers. If the party holding the ROFR chooses not to proceed with the transaction, the seller then has the liberty to consider offers from other parties. This provision is commonly favored by real estate lessees as it affords them priority access to the properties they currently occupy. However, it's essential to note that while ROFR provides a level of control for the holder, it may also impose limitations on the potential offers the owner could receive from other interested parties vying for the property.

The Right of First Offer (ROFO) is a contractual agreement that grants a party the opportunity to receive an initial offer before the asset or property is offered to others. This right allows the holder to propose terms for a transaction, and the owner must consider this offer before seeking offers from third parties. Unlike the Right of First Refusal (ROFR), the holder of a ROFO is not obligated to match competing offers; they simply get the chance to make the first move in negotiations. This provision is commonly used in various contracts, including real estate agreements and business partnerships, providing a level of control and preference to the party with the right to the first offer. It allows the holder to potentially secure the asset or property without the pressure of an immediate match.

Strike price is the price at which the option contract allows the ESOP holder to buy one share of the company’s stock.

This value is defined at the time of the grant and is set by the Fair Market Value (FMV) when the employee options are granted. If the ESOP holder chooses to exercise the options and buy shares when they are valued at a higher market value, they stand a chance to realize a profit.

Employee stock option plans come with a designated vesting period. This vesting period is tied to the criteria of vesting which may be time or performance. However, despite these conditions, there is a possibility that an event may lead to a withdrawal of the terms of the vesting schedule.

Now, if this vesting period is nullified based on a single event or a single factor, it is called a single trigger.

An example of a single trigger is where the sale of the company automatically triggers the vesting and distribution of employee stock options.

Spread refers to the difference between the fair market value of a share on the exercise date and the strike price.

A positive spread means the stock has appreciated, providing employees with a financial gain. On the other hand, a negative spread occurs when the stock value is lower than the grant price, resulting in a financial loss for employees upon exercise.

Stock options represent an equity compensation wherein employees can purchase a set number of shares at a pre-set price. They're frequently integrated into compensation plans by startups, private firms, and corporations to attract potential hires. These options allow you to partake in the company's growth and success, often included in the overall compensation package.

Stock Appreciation Rights (SARs), specifically Phantom Stock, represent compensation companies offer to their employees, linking their rewards to the organization's stock performance without granting actual ownership. With SARs, employees receive virtual or "phantom" units equivalent to the value of the company's stock. These units follow a vesting schedule, typically based on tenure or performance milestones, determining when employees can access the accrued benefits.

It's crucial to note that, unlike traditional stock options, SARs don't confer ownership rights or voting privileges to employees. Instead, they serve as a tool to motivate and retain talent by aligning their incentives with the company's success while avoiding actual equity dilution.

Shareholder agreement constitutes a legally enforceable contract that shows the relationships among a company's stakeholders: shareholders, directors, and owners. It serves as an agreement for the business's operations, detailing all parties' rights, duties, and operational guidelines. Creating and comprehending this agreement is pivotal for a business's success. Research has shown that the absence of a robust shareholder agreement often contributes to business failures. Additionally, such an agreement serves as a shield, safeguarding business owners and shareholders against unnecessary conflicts throughout the business's evolution.

A share subscription agreement outlines the conditions under which an investor commits to buying shares from a private company. It's commonly used to formalize initial understandings outlined in a term sheet between the involved parties. This agreement is prevalent during the initial fundraising stages of a company or when it decides to raise additional capital. Moreover, it clarifies the rights, responsibilities, and obligations of each party involved in the transaction.

This is the portion of the capital that has been just subscribed or promised to be bought for shares by the investors. The actual exchange of money and shares has not been done.

When companies offer their shares for sale they can be undersubscribed or oversubscribed. Over-subscribed means the number of applications received for buying is greater than the number of shares offered. Under-subscribed means the number of applications received is less than the shares offered.

Think of it like reserving a table at a restaurant, you don’t actually pay money – it’s just a promise. Similarly, in business, subscribed capital represents the agreed-upon investment from shareholders, indicating their intention to contribute funds in the future.

Stock split entails splitting or dividing the stock into multiple units. A stock split is typically expressed as a ratio, such as 2-for-1 or 3-for-1. For example, in a 2-for-1 stock split, shareholders receive two shares for every share they previously held, and the stock price is halved. It's like cutting a pizza into more slices - the total amount of pizza stays the same, but each slice becomes smaller.

Due to a stock split the share count increases i.e. the total number of outstanding shares multiplied by the split ratio, and the share price decreases i.e. the individual share price is proportionally divided by the split ratio. The key point to note is that a stock split does not change the total value or percentage of one’s investment, only the number of shares you own and their individual price changes.

Secondary transactions occur when an existing stakeholder sells their company shares either to another shareholder or back to the company. Importantly, these transactions do not impact the company's capital or the number of shares issued. Instead, the sole change lies in the ownership of the shares. Such share transactions are recognized as highly efficient liquidity rounds.

A term sheet is a blueprint summarizing the crucial terms and conditions of an investment or exit agreement. It's a preliminary agreement that provides clarity and scope of negotiation before proceeding to a detailed legal agreement. Typically, it's supplied by - angel investors, venture capitalists (VCs), financial bodies, or the acquiring entity in mergers and acquisitions.

Think of a term cheat sheet as a roadmap leading to a binding agreement. Its purpose is to initiate discussions and negotiations, ensuring all parties share a common understanding and alignment before formalizing a final contract.

Tag-along rights, also known as "co-sale rights" are provisions in shareholder agreements that protect minority shareholders. Suppose a majority shareholder decides to sell their shares to a third party. In that case, tag-along rights give minority shareholders the option to join the sale and sell their shares on the same terms and conditions as the majority shareholder. This ensures that minority shareholders aren't left behind or subjected to unfavorable terms when a significant sale occurs. Tag-along rights provide a level of protection and allow minority shareholders to participate in favorable opportunities, maintaining their interests in the company. In essence, tag-along rights are safeguards that prevent the dilution of minority shareholders' ownership and value in the event of a majority shareholder's sale.

Tag-along rights let minority shareholders choose to sell without obligation, unlike drag-along rights, which mandate their participation in a sale decided by the majority.

Vesting is a process by which an individual gains ownership to a particular asset over time, most commonly stock options where there is gradual hike in ownership rights by an employee over a specified period. The vesting period is predetermined by the employer and signifies the duration an employee must remain with the company before fully realizing the benefits. When an employee receives equity compensation with vesting, they don't immediately own the entire grant.

For example, in a four-year vesting period, an employee might gain 25% ownership rights each year, becoming fully vested after the fourth year. If an employee leaves before the vesting period concludes, they may forfeit some or all of the benefits. The mechanism designed to incentivize employee retention and align their interests with the company's long-term success.

A vesting schedule outlines the timeline over which an individual gains ownership rights to the granted equity. It is a crucial component of employee compensation plans designed to encourage long-term commitment and align the interests of employees with the company's success.

Typically, a vesting schedule is set by the employer and specifies the duration over which the employee must remain with the company to fully realize the benefits of the equity grant. The schedule breaks down the vesting period into increments, often monthly, quarterly, or annually, during which a certain percentage of the total equity becomes accessible. If the employee leaves before the vesting period concludes, unvested portions of the equity may be forfeited. Vesting schedules serve to retain talent and align employees with the company's long-term objectives.

A valuation report offers data about a company’s true worth or value in terms of market competition, asset values, and income values. The estimated fair value of the company can be calculated with methods such as the discounted cash flow (DCF) method, comparable company analysis, or asset-based approach.

These reports are especially important at times of raising funds, mergers, acquisitions, tax purposes, financial reporting, and other scenarios needed to calculate the value of the companies (eg. ESOPs). Various factors like company growth rate, financials, competitors, business nature, etc. are taken into consideration while preparing the reports.

Valuation reports are typically prepared by qualified professionals, such as chartered financial analysts (CFAs), certified public accountants (CPAs), or valuation specialists. These professionals have the expertise and experience to analyze complex financial data and apply sophisticated valuation methods by conforming to regulatory principles like GAAP.

Venture debt is a flexible form of loan/debt financing tailored for early-stage startups with backing from venture capital. It permits startups to secure capital without immediate dilution. Unlike conventional loans, it doesn't require collateral or positive revenue. Also, venture capitalists (VCs) often provide valuable operational and strategic guidance to boost startup success.

Repayment of venture debt involves returning the principal amount along with interest within a predetermined timeframe. Typically employed as a supplementary capital source, funds acquired through venture debt can be directed towards research and development, procuring equipment/supplies, or expanding operational reach.

Why choose debt financing over equity financing? Debt financing doesn't involve dilution of company ownership. However, this advantage is countered by the trade-off of higher interest rates and a relatively shorter maturation period, typically spanning 12 to 24 months.

A veto is a super-qualified voting right given to shareholders with a minority to override specific decisions taken by the majority stake or company management, typically related to stock issuance or major corporate changes. It is part of Reserved Matters. Also, this privilege empowers participants to protect their interests by preventing actions that may adversely affect their equity or overall financial well-being within the ESOP framework.

It is a computation employed in anti-dilution protection, particularly in the occurrence of a down round. This calculation is utilized to modify the value of existing shareholders' preference shares to a new weighted average price, serving as the conversion price.

Two primary methods for this calculation include

• Broad-based weighted average
• Narrow-based weighted average

The broad-based approach considers all outstanding (issued) shares, encompassing convertible instruments assumed to be converted to equity, on a fully diluted basis. Conversely, the narrow-based method only considers equity and preference shares that convert to equity, providing a more focused evaluation of the impact on shareholders' equity values during a down round.