At a glance
| Law | Shareholder approval | Minimum vesting | ROC forms | Our fee |
|---|---|---|---|---|
| s.62(1)(b), Companies Act, 2013 and Rule 12 | Special resolution | 1 year from grant | MGT-14, then PAS-3 on each allotment | On quote |
What an ESOP is, in plain words
An employee stock option is a right, not a share. The employee can buy a fixed number of shares at a pre-agreed exercise price once the options vest, and becomes a shareholder only on exercise and allotment.
Four terms come up in every scheme. Grant is the day the company awards the options. Vesting is when the employee earns the right to exercise. Exercise is when the employee pays the exercise price and asks for shares. Allotment is when the company issues the shares and files the return of allotment.
An ESOP costs the company no cash on grant and aligns employees with the value they help build. It also dilutes existing shareholders, which is why the pool is sized and approved in advance.
The legal rules for an unlisted company
An unlisted company issues ESOPs under section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Listed companies follow the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 instead.
Who can receive options
Rule 12 defines who counts as an employee for an ESOP:
- A permanent employee of the company, working in India or outside India
- A director of the company, whole-time or not, other than an independent director
- An employee or director of a subsidiary or holding company, as the rule allows
Two groups are excluded: an employee who is a promoter or belongs to the promoter group, and a director who holds, directly or indirectly, more than 10% of the company's equity shares. Consultants, advisors and freelancers are not employees, so section 62(1)(b) ESOPs cannot be granted to them.
Promoters in startups
A startup gets relief from both exclusions. For ten years from the date of its incorporation, a startup can grant ESOPs to promoters and to directors holding more than 10%.
"Startup" here follows the government's startup definition, so keep your DPIIT recognition in order. After the ten years, new grants to promoters stop; the scheme should say what happens to grants already made.
What the special resolution must disclose
The explanatory statement for the special resolution must set out the scheme's key terms. Rule 12 requires, among other things:
| Disclosure | What you decide |
|---|---|
| Total options to be granted | The pool size |
| Classes of employees entitled | Eligibility |
| Appraisal process | How grants are decided |
| Vesting requirements and maximum vesting period | The vesting schedule |
| Exercise price or the formula for it | Pricing |
| Exercise period and process | How and when employees exercise |
| Lock-in period, if any | Any restriction after exercise |
| Maximum options per employee | Per-person cap |
| Method used to value the options | Accounting basis |
| Conditions under which vested options lapse | Lapse rules, for example termination for misconduct |
| Period for exercise after resignation or termination | Post-exit window |
Rules that apply after grant
- There must be at least one year between grant and vesting.
- The company is free to set a lock-in on shares after exercise.
- Options cannot be transferred, pledged or mortgaged.
- Option holders have no voting or dividend rights until shares are issued.
- On death or permanent incapacity, options vest as the rule provides, for the legal heirs or the employee.
- On resignation or termination, options not yet vested lapse, in line with the scheme.
- The Board's report each year discloses options granted, vested, exercised and outstanding, with the other details Rule 12 lists.
- The company keeps a Register of Employee Stock Options in Form SH-6 at its registered office.
Designing the ESOP before drafting it
Design decisions drive the drafting, not the other way round. We start with your cap table and hiring plan, agree the choices with founders and your lead investor, and only then draft.
Pool size
The pool is the number of shares reserved for options, shown on a fully diluted basis. Size it from the roles you plan to hire over the next two or three years and what each role will need to join.
Investors often ask for the pool to be created or topped up before a round, so it dilutes founders rather than the new investor. Check your founders agreement, shareholders' agreement or term sheet for pool terms, and check that authorised capital covers the pool; if not, increase the authorised share capital first.
Vesting and cliff
The law sets only a floor: one year between grant and vesting. Many startups use four-year vesting with a one-year cliff, then monthly or quarterly vesting.
You can also add performance vesting for senior hires, or acceleration on an exit or change of control. Every such term must be in the scheme and the grant letter, so employees know exactly what they hold.
Exercise price and exercise window
The exercise price is fixed at grant, either as a number or as a formula disclosed in the special resolution. A low exercise price rewards employees but increases the taxable perquisite on exercise.
Set a clear exercise window, including what happens after an employee leaves. Many unlisted companies allow exercise only on a liquidity event, which means employees are not asked to pay and be taxed while the shares cannot be sold.
The exercise window after resignation is usually the most negotiated clause in the scheme. A short window forces a departing employee to find the exercise price and the tax quickly or lose the options; a longer window makes the options genuinely valuable to hold. Decide it deliberately, because it has to be disclosed in the special resolution.
Leaving the company
Decide in advance what a good leaver and a bad leaver keep. Common patterns: unvested options lapse on exit, vested options can be exercised within a fixed period, and all options lapse on termination for misconduct.
What goes into an ESOP policy
The ESOP policy, or scheme document, is the rulebook. The board adopts it and shareholders approve it by special resolution.
A complete scheme covers: the name and purpose; the pool size and the source of shares; eligibility and the appraisal process; the vesting schedule and any performance conditions; exercise price and exercise period; lapse and leaver rules; corporate actions such as bonus, split or merger; tax recovery and withholding; administration by the board or a committee; amendment and termination; and the governing law.
Alongside the scheme you need a grant letter template, an acceptance form, an exercise notice, and the SH-6 register. We draft all of them together so the terms match.
Direct route or ESOP trust
Most private companies use the direct route: the company grants options and issues new shares on exercise. It is simpler, needs no separate entity and suits smaller pools.
A trust route places shares with an employee welfare trust that holds them for employees. Companies use it where they want a warehouse of shares, to buy back shares from leavers, or to manage liquidity events. It needs a trust deed, trustees and funding, and any loan from the company to the trust must meet section 67 of the Companies Act, 2013.
| Point | Direct route | Trust route |
|---|---|---|
| Shares come from | Fresh issue on exercise | Shares held by the trust |
| Set-up | Scheme and special resolution | Scheme, special resolution, trust deed, trustees |
| Suits | Early-stage companies, smaller pools | Larger pools, buybacks from leavers, liquidity events |
| Extra checks | Authorised capital | Funding of the trust under section 67 |
How ESOPs are taxed
Employees pay tax twice: as salary when they exercise, and as capital gains when they sell. The company has no tax on grant or vesting. The rules below are for FY 2025-26 under the Income-tax Act, 1961.
At exercise
On exercise, the difference between the fair market value on the exercise date and the exercise price is a perquisite taxed as salary under section 17(2)(vi). The employer deducts TDS on it under section 192.
For an unlisted company, the fair market value comes from a valuation by a SEBI-registered Category I merchant banker, as on a date not earlier than 180 days before the exercise date. Plan valuations around exercise windows so the report is current.
At sale
When the employee sells the shares, the gain is capital gains. The cost is the fair market value that was taxed as a perquisite, so the same amount is not taxed twice. Whether the gain is long-term or short-term depends on how long the shares were held after allotment.
Tax deferral for eligible startups
Employees of an eligible startup can defer the tax on exercise. Under section 192(1C) of the 1961 Act, the tax is paid within 14 days of the earliest of three events:
- 48 months from the end of the relevant assessment year
- The date the employee sells the shares
- The date the employee leaves the employer
The deferral applies only to an "eligible start-up referred to in section 80-IAC", which means a company holding the Inter-Ministerial Board certificate for the startup tax holiday. DPIIT recognition alone is not enough. See our section 80-IAC and section 140 tax holiday page for the certificate.
From Tax Year 2026-27
From Tax Year 2026-27, ESOP perquisites, TDS and the startup deferral are governed by the Income-tax Act, 2025, which carries equivalent provisions. We confirm the applicable sections for your grants and payroll before the first exercise under the new Act.
Approvals, ROC filings and allotment
The approval path runs from the board to shareholders to the ROC. Each allotment on exercise then has its own filing.
- Check the articles. Confirm that the articles of association permit the issue; amend them if needed.
- Board meeting. The board approves the draft scheme and calls a general meeting.
- Special resolution. Shareholders pass the special resolution with the explanatory statement disclosures.
- MGT-14. File the special resolution with the ROC in Form MGT-14 within 30 days.
- Grants. Issue grant letters and record them in the SH-6 register.
- Exercise and allotment. On exercise, the board allots shares, the company issues share certificates or credits demat accounts, and files the return of allotment in Form PAS-3.
- Annual disclosure. The Board's report carries the ESOP disclosures every year.
If an employee who exercises is resident outside India, the issue also has to meet FEMA rules. We check that before the first such allotment and coordinate the reporting with our FDI filing team.
Keep the registers and the cap table in sync
Three records have to agree at all times: the option grant register (SH-6), the register of members and allotments, and the cap-table model the founders and investors use. When they drift apart, the gap surfaces at the worst moment, in a funding round or a sale, when every grant and exercise is checked. Pick one source of truth, update the others from it after every grant, exercise and share transfer, and reconcile them before any round.
Fees
ESOP work varies with the size of the pool, the number of grants and whether you need a trust, so we quote after a short call. ROC fees are separate and depend on your authorised capital.
| Item | Amount |
|---|---|
| Regikart professional fee: ESOP design, scheme drafting, resolutions, MGT-14 filing and grant documents | Fee on quote |
| Government fee: MGT-14 (special resolution) | ROC normal fee by authorised capital: ₹200 below ₹1 lakh, ₹300 from ₹1 lakh, ₹400 from ₹5 lakh, ₹500 from ₹25 lakh, ₹600 from ₹1 crore |
| Government fee: PAS-3 (each allotment on exercise) | Same ROC normal fee scale as MGT-14 |
| Late filing | Additional fee as a multiple of the normal fee, rising with the delay |
| Merchant banker valuation for exercise | Quoted by the valuer, if needed |
Professional fees exclude GST at 18%. Government fees, where they apply, are paid at actuals to the department and are shown separately. Fees verified on 21 September 2026.
ESOP alternatives: sweat equity, phantom stock and SARs
An ESOP is not the only way to share value. The right tool depends on who you want to reward and whether you want to issue shares.
| Tool | What the person gets | Who can receive it | Key rule |
|---|---|---|---|
| ESOP | Option to buy shares later | Employees and directors as defined in Rule 12 | s.62(1)(b), special resolution |
| Sweat equity | Shares issued for know-how or value addition | Directors and employees | s.54, special resolution |
| Phantom stock or cash SARs | Cash linked to share value, no shares | Anyone the contract covers | Contractual; no share issue |
For consultants and advisors, who cannot receive section 62(1)(b) ESOPs, a cash-settled plan or a direct share issue at a proper valuation is usually the answer. We help you pick and document it.
Mistakes we fix most often
- Grants before approval. Options promised in offer letters before the special resolution is passed.
- No room in authorised capital for the pool, discovered at the first exercise.
- Promoter grants after the ten-year window, or by a company that is not a startup.
- Vesting inside one year from grant, which Rule 12 does not allow.
- Grants to consultants under the ESOP scheme.
- Assuming DPIIT recognition gives tax deferral. It needs the IMB certificate.
- Missing PAS-3 after allotments, or an SH-6 register that was never opened.
- A scheme that conflicts with the shareholders' agreement on pool size or investor consent.
Why founders use Regikart for ESOPs
An ESOP touches company law, tax and your investors. We handle all three in one engagement.
- Reviewed by a Company Secretary who drafts and files the approvals.
- Design before drafting. Pool, vesting and exit rules are agreed on your cap table first.
- Tax in plain words for your employees, including whether your company qualifies for deferral.
- Linked work under one roof: share valuation, term sheet review, DPIIT recognition and the shareholders' agreement.
- 250+ clients served from Kolkata, Delhi and Bengaluru.