What is an ESOP Plan? A Clear Guide for Indian Startups and Private Limited Companies

Why ESOP in India Matters?

If you’re building a startup in India or running a private limited company, chances are you’ve heard the term “ESOP.” But what is an ESOP plan really? Why do companies—from small tech startups to fast-scaling fintechs—offer equity to employees? And how does it work from both a legal and operational point of view?

This guide simplifies the entire concept and process of setting up an Employee Stock Ownership Plan (ESOP) tailored to Indian startups and private limited companies.

What is an ESOP in India?

An ESOP, or Employee Stock Ownership Plan, is a formal scheme that allows a company to grant shares of its equity to employees. It acts as a reward and retention tool, turning employees into stakeholders. In India, ESOPs are governed by Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 under the Companies Act, 2013.

How It Works:

• Grant: The company offers a right to buy shares at a pre-decided price.
• Vesting: Employees earn the right to exercise ESOPs over time.
• Exercise: The employee pays the exercise price to convert options into shares.
• Allotment: Shares are officially transferred to the employee’s name.

Benefits of Offering ESOPs in a Startup or Pvt. Ltd Company

• Helps retain and attract top talent without immediate cash outflow
• Creates a strong sense of ownership and motivation
• Boosts credibility with investors and improves startup valuation
• Reduces attrition during early scaling stages
• Aligns long-term company goals with employee rewards

Step-by-Step: How to Create an ESOP Plan in India

• Board Resolution approving the creation of an ESOP Scheme
• Special Resolution by shareholders under Section 62(1)(b) of the Companies Act
• Draft the ESOP Scheme, covering eligibility, vesting period, lock-in, and exercise process
• Get a valuation from a SEBI-registered Category-I Merchant Banker (for unlisted companies)
• Issue Grant Letters to selected employees
• Allot shares after exercise and file Form PAS-3 with the ROC
• Vesting Rules & Exercise Window

In India, the minimum vesting period is 1 year. Most startups use a 4-year vesting schedule with a 1-year cliff. This ensures employees stay committed for at least a year before they earn any part of their options.

The exercise period varies by company. It’s often 3 to 6 months from the employee’s exit date or immediate upon vesting.

ESOP Compliance Checklist for Indian Pvt Ltd Companies

• Maintain Board and Shareholder approval documentation
• Adhere to Rule 12 of Companies (Share Capital and Debentures) Rules
• Record ESOP details in statutory registers
• File ROC forms like PAS-3 and MGT-14 (if applicable)
• Disclose ESOPs in the Board’s annual report
• Update cap table post-allotment

ESOP Taxation in India

Employees are taxed in two stages:

• At exercise: Treated as perquisite under “Income from Salary” based on FMV
• At sale: Capital gains tax applies based on holding period

Proper planning is key. Startups should educate employees on tax impact and possibly offer tax advisory support.

Common Mistakes to Avoid in designing ESOP Plan

• Granting ESOPs without formal board/shareholder approval
• No vesting schedule or poor scheme documentation
• Not conducting share valuation before grant/allotment
• Lack of transparency with employees about the plan
• Missing ROC filings or disclosures

Suggested Read :

Analysis of ESOP Section of Companies Act, 2013
How ESOPs Can Benefit Private Limited Companies
ESOP Vs Sweat equity shares

FAQs on ESOP Plans for Startups and Private Limited Companies

1. What is an ESOP Plan in simple terms?
An ESOP (Employee Stock Ownership Plan) allows employees to own a part of the company by buying shares at a pre-decided price. It helps align employee performance with company growth.

2. Can a private limited company offer ESOPs in India?
Yes, private limited companies can issue ESOPs under the Companies Act, 2013. The company must pass a board and shareholder resolution and follow the prescribed legal process.

3. Why do startups prefer ESOPs for employees?
Startups often can’t offer high salaries, so they use ESOPs to attract and retain talent. ESOPs give employees long-term incentives by tying their rewards to the company’s success.

4. Who is eligible for ESOPs in a company?
Typically, permanent employees, directors (excluding promoters or founders in many cases), and sometimes advisors or consultants, based on the ESOP policy defined by the company.

5. What is a vesting period in ESOPs?
The vesting period is the minimum time employees must stay with the company to claim their shares. The legal minimum is 1 year, but most startups use a 3–4 year schedule with a 1-year cliff.

6. Are ESOPs taxed in India?
Yes, ESOPs are taxed twice — first as a perquisite under “salary” at the time of exercise, and later as capital gains when shares are sold. DPIIT-recognized startups may get deferred tax benefits.

7. How is the ESOP exercise price decided?
The company usually sets the exercise price at the time of grant. It may be equal to or less than the fair market value (FMV), based on a certified valuation report.

8. Do employees become owners under ESOPs?
Yes, but only after they complete the vesting period and exercise their options. Once shares are allotted, they officially become shareholders in the company.

9. Can I sell ESOP shares anytime after exercising them?
In private limited companies, liquidity is limited — so shares can only be sold during buyback rounds or to incoming investors, unless the company lists on a stock exchange.

10. Is there any compliance involved in issuing ESOPs?
Yes, ESOP issuance requires proper board and shareholder approvals, maintaining an ESOP register, drafting the ESOP scheme, and timely ROC filings like MGT-14 and SH-6.

Final Word: Should Your Company Offer an ESOP Plan?  

If you are a startup or private limited company in India, an ESOP plan is not just a trendy HR tool—it’s a strategic lever to scale sustainably, build a loyal workforce, and position your brand for serious investment. Done right, it can be your biggest competitive edge.

Need help drafting or filing your ESOP plan? Ebizfiling offers legal, compliance, and advisory support for startups and companies planning equity grants in India.