Overview
An Employee Stock Option Plan gives employees the right, but not the obligation, to buy shares at a fixed price after a vesting period. For startups it is a way to share future upside when salaries cannot compete with larger firms.
The Companies Act, 2013 and its rules require a special resolution of shareholders to approve the scheme, disclosure of its terms, a minimum gap of one year between the grant and the vesting of an option, and a framework for the exercise price and period. Promoters and certain large shareholders and independent directors are generally excluded, with relaxations available for eligible startups.
Tax arises in two steps. On exercise, the difference between the fair value of the share and the exercise price is taxed as a salary perquisite for the employee. On sale of the shares, capital gains tax applies. Eligible startups can get a deferral of the perquisite tax for a period, and our work includes checking whether you qualify. Foreign employees and investors add FEMA and other points that must be handled separately.
Is an ESOP the right fit?
It works best when the company expects to grow in value and wants key people to stay.
Usually a good fit if
- You are a startup that cannot yet pay market salaries to senior hires.
- You are about to raise funding and investors expect an option pool.
- You want to reward long-term contributors and keep them for several years.
- You have a growing team and want a structured, fair way to grant equity.
Think twice if
- The company is not planning to grow or exit; options may not hold perceived value.
- You are a partnership or LLP; the ESOP rules under the Companies Act apply to companies only, and other structures are needed.
Key benefits
Attracts and retains talent
Ownership motivates people to stay and build value.
Preserves cash
Rewards are linked to future value, not current salary.
Investor-ready
A properly approved plan and pool are part of due diligence.
Aligned incentives
Employees share in the company's success.
Tax planning
Structure and timing can reduce friction for employees.
Clear governance
Rules on grants, vesting, leavers and exit are written down.
What we need from you
We need company records and the commercial design of the plan.
Company records
- Certificate of incorporation, memorandum and articles of association
- Current shareholding and cap table
- Latest financial statements and any investor agreements
- Recent valuation reports, if any
Plan design inputs
- Size of the option pool as a share of the capital
- Who will receive grants and in what numbers
- Vesting schedule, cliff and exercise period
- Treatment of leavers, terminations and a sale of the company
Approvals and filings
- Board and shareholder meeting details
- Draft resolution and explanatory statement
- Details of employees to be granted options
How the process works
Understand your goals 2 to 3 days
We discuss whom you want to reward, what is at stake and how investors may view it.
Design the plan 3 to 5 days
We propose the pool, vesting, exercise price, leaver rules and exit treatment.
Draft the scheme and grant documents 4 to 7 days
ESOP scheme, grant letters and exercise forms are prepared.
Board and shareholder approval 1 to 2 weeks
Board meeting, special resolution and filings with the registrar.
Valuation 1 to 2 weeks
A valuation by a registered valuer or a merchant banker for tax purposes, where required.
Grant and administer Ongoing
Grant letters are issued, and a register tracks vesting, exercise and leavers.
How long it takes
| Design and drafting | 1 to 2 weeks |
| Approvals and filings | 1 to 2 weeks |
| Overall to first grants | About 3 to 6 weeks |
Valuation and shareholder approval often decide the timeline.
Running the plan
An ESOP needs regular administration.
- Maintain the registerRecord grants, vesting, exercise and lapses for each employee.
- ValuationsKeep valuation reports for exercise events and tax withholding.
- Withhold tax on exerciseThe company deducts tax on the perquisite at exercise.
- Report to the registrarFile required forms after allotment of shares.
- Communicate with employeesClear plain-language summaries avoid misunderstandings.
ESOP tax events at a glance
| Event | Who is taxed | How |
|---|---|---|
| Grant | No one | No tax at grant |
| Vesting | No one | No tax at vesting |
| Exercise | Employee | Perquisite taxed as salary on the difference between value and exercise price |
| Sale of shares | Employee | Capital gains on the increase after exercise |
| Eligible startup employee | Employee | Deferral of the perquisite tax for a set period |
Frequently asked questions
How much of the company should the pool be?
There is no fixed rule. Early-stage startups often reserve a share of the capital for the pool, and investors may ask for a top-up at funding. We help you size it for your plan.
What is vesting?
The period over which options become exercisable. A minimum gap of one year between grant and vesting is required, and many plans vest over four years with an initial cliff.
How are options taxed?
On exercise, the benefit is taxed as salary for the employee. On sale of the shares, capital gains tax applies. Eligible startups can defer the first tax for a set period.
Can founders receive ESOPs?
Promoters and directors who hold more than ten percent of the shares are generally excluded. Startups get some relaxations for a defined period.
What happens when an employee leaves?
The plan should say. Usually unvested options lapse, and vested ones may be exercised within a notice period, as set out in the scheme.
Can an LLP offer ESOPs?
The statutory ESOP route is for companies. LLPs can use other incentive structures, but they work differently.
This page is general information to help you prepare, not legal, tax or professional advice for your situation. Rules, forms, thresholds and due dates change, so we confirm the current position before we file anything for you. Taxswami Consultants is an independent professional services firm and is not a government body.