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.
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.
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.
Employees are taxed in two stages:
Proper planning is key. Startups should educate employees on tax impact and possibly offer tax advisory support.
Analysis of ESOP Section of Companies Act, 2013
How ESOPs Can Benefit Private Limited Companies
ESOP Vs Sweat equity shares
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.
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.
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