Employee stock option scheme

Category: Corporate Advisory. From ₹19,999. Typical timeline: 14–21 days.

Overview

An Employee Stock Option Plan (ESOP) lets a company grant employees the right to acquire equity shares in future at a pre-determined price, aligning employee incentives with company growth and serving as a valuable non-cash retention tool, especially for cash-constrained startups. Kanoons designs the ESOP pool size, vesting and exercise structure, drafts the scheme document and grant letters, and ensures the plan complies with the Companies Act, 2013 and, where relevant, SEBI regulations for listed companies.

Who needs it

• A startup wanting to offer equity-based compensation to attract talent without a large cash outlay
• A growth-stage company formalising an existing informal option promise into a proper scheme
• A company preparing for fundraising where investors expect an ESOP pool to be carved out
• A business wanting to design a fresh vesting schedule tied to performance or tenure milestones

Eligibility

• Private and public companies wanting to grant stock options to employees or directors (other than promoter directors and independent directors, for private companies)
• Companies with shareholder approval to create an ESOP pool
• Companies at any stage — early-stage startups to growth companies designing a formal option scheme

Documents required

• Latest cap table and shareholding pattern
• Board resolution and, where required, special resolution approving the ESOP pool
• List of eligible employees and proposed grant sizes
• Latest valuation report for setting exercise price
• Existing employment agreements, if vesting is to be tenure-linked

Process

1. Pool sizing — ESOP pool size is determined as a percentage of fully diluted equity, factoring in future funding round dilution.
2. Scheme design — Vesting schedule, cliff period, exercise price and exercise window are designed to match company objectives.
3. Drafting — The ESOP scheme document, grant letter template and board/shareholder resolutions are drafted.
4. Approvals — Board and shareholder approval is obtained for the scheme as required under the Companies Act.
5. Grant letters & administration — Individual grant letters are issued to employees and an option register/tracker is set up for administration.

Government fees

• MGT-14 filing fee (for special resolution): ₹300–₹600 depending on authorised capital slab
• Stamp duty on grant letters: Nominal, varies by state

Professional fee

Starts at ₹19,999 depending on company stage and complexity of vesting structure; covers pool sizing advice, scheme drafting, resolutions and grant letter templates.

Timeline

A standard ESOP scheme is designed and finalised in 14–21 working days, including drafting, approvals and grant letter preparation; more customised multi-tranche schemes can take slightly longer.

Deliverables

• ESOP scheme document approved by the board/shareholders
• Board and special resolution drafts and MGT-14 filing where applicable
• Grant letter template and sample option register

Frequently asked questions

Can promoter directors receive ESOPs in a private company?

Promoter directors and independent directors are generally excluded from receiving ESOPs under the Companies Act framework applicable to private companies, subject to limited exceptions for startups recognised by DPIIT.

Is shareholder approval mandatory for an ESOP scheme?

Yes, a special resolution of shareholders is required to approve the ESOP scheme, along with a separate resolution if options are granted to employees of a subsidiary or holding company.

When is ESOP taxed in the employee's hands?

ESOPs are taxed as a perquisite at the time of exercise on the difference between fair market value and exercise price, and again as capital gains when the shares are eventually sold, subject to specific deferral benefits available to eligible startups.

Common mistakes

• Setting the ESOP pool size without accounting for dilution from future funding rounds
• Granting options informally without a board-approved scheme and written grant letters
• Not aligning vesting schedules with actual retention or performance goals
• Overlooking the special resolution and MGT-14 filing requirement, making the scheme legally infirm

Penalties for non-compliance

• Granting ESOPs without a valid shareholder-approved scheme can render the grant invalid and unenforceable against the company
• Failure to file the special resolution (MGT-14) within 30 days can attract late filing fees and additional government fee under the Companies Act
• Incorrect tax withholding on ESOP exercise can expose the company to interest and penalty for TDS default

Legal references

• Companies Act, 2013 (Section 62(1)(b)) and Companies (Share Capital and Debentures) Rules, 2014 — govern issuance of ESOPs by companies
• SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 — govern ESOPs for listed companies
• Income-tax Act, 1961 — governs taxation of ESOP perquisite and subsequent capital gains