The Legal Checklist for Issuing ESOPs in India  

Introduction

For Indian startups and private limited companies, ESOPs (Employee Stock Option Plans) are more than just a retention tool — they’re a key part of growth, equity management, and startup culture. But issuing ESOPs is a legal process, not just a strategic one.

Failing to follow the required steps under the Companies Act, SEBI regulations (for listed entities), or MCA filings can result in serious compliance breaches and trouble during audits or funding rounds.

This guide gives you a precise legal checklist to issue ESOPs correctly in India — whether you’re a DPIIT-recognized startup, a private limited company, or an unlisted public company preparing to offer employee equity.

Step-by-Step Legal Checklist for Issuing ESOPs

1. Determine ESOP Eligibility

Ensure your company is legally eligible to issue ESOPs. As per Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014:
ESOPs can be issued to permanent employees, directors, or officers (excluding independent directors).
Promoters and directors holding >10% equity are not eligible — except in the case of DPIIT-recognized startups (for 10 years from incorporation).

2. Draft an ESOP Scheme

• Create a detailed ESOP scheme that outlines:
• Who can receive options
• Vesting criteria and lock-in periods
• Exercise price and timeline
• Method of settlement (shares or cash)

This scheme must comply with applicable laws and be approved by both the board and shareholders.

3. Pass a Board Resolution

Convene a board meeting to:

• Approve the ESOP scheme
• Authorize calling of an extraordinary general meeting (EGM) or pass via AGM

4. Obtain Shareholder Approval

A special resolution must be passed in a general meeting to approve the ESOP scheme.
The explanatory statement should include disclosures under Rule 12(2), such as total number of options, method of valuation, pricing formula, etc.

5. File MGT-14 with the ROC

File Form MGT-14 within 30 days of passing the special resolution. This form includes board and shareholder resolutions and forms the legal base for ESOP allotment.

6. Maintain Register SH-6

Create and maintain the Register of Employee Stock Options (Form SH-6), which includes details of grants, vesting, exercise, and cancellation of ESOPs.

7. Issue Grant Letters

Send ESOP grant letters to eligible employees. These must clearly state:

• Number of options granted
• Vesting period
• Exercise price

Any performance criteria or conditions

8. Handle Vesting and Exercise Events

After the vesting period, employees may choose to exercise their options. This exercise must be supported by:

• Board approval of share allotment
• Filing of PAS-3 with the ROC within 15 days of allotment

9. Valuation and Tax Compliance

A fair market valuation report by a Registered Value (or Merchant Banker for FEMA-compliance, if applicable) is crucial at the time of grant and exercise for both company law and tax purposes.

10. SEBI Compliance (for listed companies)

If you’re a listed entity, you must additionally follow SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021. This includes detailed disclosures to stock exchanges, trust structure norms (if used), and annual reporting.

Practical Considerations for Issuing ESOPs

• ESOPs should be aligned with your startup’s fundraising plans — they directly affect cap table structure.
• Founder dilution, employee churn, and accounting treatment (per Ind AS 102) must also be considered.
• For VC-backed companies, ESOP pools and vesting schedules are often negotiated at the term sheet level.
• SEBI requires detailed disclosures on ESOPs in DRHPs — crucial if you’re planning an IPO.

Suggested Read :

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

FAQs – ESOP Legal Compliance in India

1. Is it mandatory to get shareholder approval for ESOPs?
Yes, a special resolution in a general meeting is compulsory under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.

2. Can ESOPs be issued to directors or promoters?
Not if they hold more than 10% of the company’s equity. However, DPIIT-recognized startups can issue ESOPs to such promoters for up to 10 years from incorporation.

3. Is there a government fee for filing ESOP-related forms like MGT-14 or PAS-3?
Yes. Filing fees depend on company type and share capital, as per the Companies (Registration Offices and Fees) Rules, 2014.

4. What’s the role of a valuation report in ESOP issuance?
Valuation is essential to determine the fair market value of shares during ESOP grant and exercise. It also impacts employee taxation.

5. Do I need to issue actual shares immediately after granting ESOPs?
No. Shares are only allotted after the employee exercises their vested options. Until then, ESOPs represent a right, not ownership.

6. Can an LLP or partnership firm issue ESOPs?
No. Only companies registered under the Companies Act, 2013 can issue ESOPs.

7. Do I need to maintain a statutory register for ESOPs?
Yes. Register SH-6 is mandatory and should include grant, vesting, exercise, and cancellation records.

8. What happens if I delay filing PAS-3 after allotment?
You may face late fees and penalties under the Companies Act. It also affects the legal validity of the allotment.

9. Can ESOPs be granted during funding rounds or M&A?
Yes, but be cautious. New investors often renegotiate pool size and vesting terms. Ensure alignment with your cap table.

10. Is professional help needed to issue ESOPs?
Highly recommended to hire a professional company like EbizFiling.com. Compliance with MCA and SEBI rules, drafting accurate scheme documents, and handling tax implications require CA/CS-level oversight.