{"id":890,"date":"2026-05-06T16:51:51","date_gmt":"2026-05-06T11:21:51","guid":{"rendered":"https:\/\/tmzon.com\/blog\/?p=890"},"modified":"2026-05-06T16:51:52","modified_gmt":"2026-05-06T11:21:52","slug":"esop-policy-startups-india","status":"publish","type":"post","link":"https:\/\/tmzon.com\/blog\/esop-policy-startups-india\/","title":{"rendered":"ESOP Policy for Startups India \u2014 Complete Guide (2026)"},"content":{"rendered":"\n<p>An ESOP (Employee Stock Option Plan) policy is a formally documented scheme under which a startup grants eligible employees the right \u2014 but not the obligation \u2014 to purchase company shares at a pre-determined price (exercise price) after completing a vesting period. In India, ESOPs for private limited companies are governed by <strong>Section 62(1)(b) of the Companies Act, 2013<\/strong> and <strong>Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014<\/strong>. Implementation requires Board approval, a shareholder Special Resolution, and filing <strong>Form MGT-14<\/strong> with the ROC within 30 days.<\/p>\n\n\n<style>.kb-table-of-content-nav.kb-table-of-content-id890_190fe0-f1 .kb-table-of-content-wrap{padding-top:var(--global-kb-spacing-sm, 1.5rem);padding-right:var(--global-kb-spacing-sm, 1.5rem);padding-bottom:var(--global-kb-spacing-sm, 1.5rem);padding-left:var(--global-kb-spacing-sm, 1.5rem);}.kb-table-of-content-nav.kb-table-of-content-id890_190fe0-f1 .kb-table-of-contents-title-wrap{padding-top:0px;padding-right:0px;padding-bottom:0px;padding-left:0px;}.kb-table-of-content-nav.kb-table-of-content-id890_190fe0-f1 .kb-table-of-contents-title{font-weight:regular;font-style:normal;}.kb-table-of-content-nav.kb-table-of-content-id890_190fe0-f1 .kb-table-of-content-wrap .kb-table-of-content-list{font-weight:regular;font-style:normal;margin-top:var(--global-kb-spacing-sm, 1.5rem);margin-right:0px;margin-bottom:0px;margin-left:0px;}<\/style>\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Why Indian Startups Use ESOPs \u2014 The Business Case<\/h2>\n\n\n\n<p>Indian startups face a fundamental hiring tension: they need world-class talent but cannot always match the cash compensation that established companies offer. ESOPs solve this by deferring part of the compensation to a future equity upside \u2014 aligning employee interests with company growth.<\/p>\n\n\n\n<p>The numbers tell the story. In 2021, 35 non-founder senior managers at Indian startups entered the \u20b9100 crore ESOP value club. Flipkart&#8217;s ESOP pool alone was worth approximately \u20b917,000 crore at the time of its merger. Zepto, PhysicsWallah, Meesho, and virtually every well-funded Indian startup now runs a formal ESOP programme as a core part of its compensation architecture.<\/p>\n\n\n\n<p><strong>The five reasons startups implement ESOPs:<\/strong><\/p>\n\n\n\n<p><strong>1. Talent acquisition at cash-light stages<\/strong> \u2014 ESOPs allow early-stage startups to compete for experienced hires who might otherwise only join well-funded companies for high cash salaries.<\/p>\n\n\n\n<p><strong>2. Employee retention<\/strong> \u2014 vesting schedules (typically 4 years with a 1-year cliff) create a strong financial incentive for employees to stay. Leaving before vesting means forfeiting unvested options.<\/p>\n\n\n\n<p><strong>3. Cash conservation<\/strong> \u2014 equity compensation reduces the cash burn on salaries during the capital-intensive early years, preserving runway for product and growth.<\/p>\n\n\n\n<p><strong>4. Alignment of interests<\/strong> \u2014 employees who own equity think and act more like owners. This drives productivity, reduces principal-agent problems, and improves decision quality.<\/p>\n\n\n\n<p><strong>5. Fundraising signal<\/strong> \u2014 investors and acquirers treat a well-structured ESOP pool as a sign of governance maturity and management quality.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">The Legal Framework \u2014 What Governs ESOPs in India<\/h2>\n\n\n\n<h3 class=\"wp-block-heading\">For Private Limited Companies (Unlisted)<\/h3>\n\n\n\n<p><strong>Section 62(1)(b) of the Companies Act, 2013<\/strong> \u2014 the primary provision authorising the issuance of shares to employees under an ESOP scheme. The issuance requires a special resolution of shareholders.<\/p>\n\n\n\n<p><strong>Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014<\/strong> \u2014 the detailed subordinate legislation specifying eligibility criteria, vesting requirements, exercise price mechanics, disclosure obligations, and the ESOP register.<\/p>\n\n\n\n<p><strong>Section 2(37) of the Companies Act, 2013<\/strong> \u2014 defines &#8220;Employee Stock Option&#8221; as the option given to directors, officers, or employees to purchase or subscribe to shares of the company at a future date at a pre-determined price.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">For Listed Companies<\/h3>\n\n\n\n<p>Listed companies must additionally comply with the <strong>SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021<\/strong> (SBEB Regulations), which impose additional requirements including a Compensation Committee, a trust mechanism for share delivery, and detailed continuous disclosure obligations.<\/p>\n\n\n\n<p>This guide focuses primarily on ESOPs for unlisted private limited companies \u2014 the dominant structure for Indian startups.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Who Is Eligible for ESOPs? \u2014 And Who Is Not<\/h2>\n\n\n\n<h3 class=\"wp-block-heading\">Eligible Persons (Rule 12(1))<\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Permanent employees<\/strong> of the company \u2014 working in India or abroad<\/li>\n\n\n\n<li><strong>Directors<\/strong> of the company \u2014 including part-time directors (but <strong>not<\/strong> independent directors)<\/li>\n\n\n\n<li><strong>Permanent employees and directors<\/strong> of the company&#8217;s subsidiary, holding company, or associate company \u2014 working in India or abroad<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Not Eligible (Rule 12(1)(c)) \u2014 The Default Rules<\/h3>\n\n\n\n<p>The following persons <strong>cannot receive ESOPs<\/strong> under normal circumstances:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Promoters or persons belonging to the promoter group<\/strong> \u2014 regardless of their designation or employment status<\/li>\n\n\n\n<li><strong>Directors holding more than 10% of the outstanding equity shares<\/strong> \u2014 directly, indirectly, through relatives, or through any body corporate<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">The Critical Startup Exemption \u2014 DPIIT-Recognised Companies<\/h3>\n\n\n\n<p><strong>The restrictions on promoters and 10% shareholders do NOT apply to startups recognised by DPIIT<\/strong> under the Startup India initiative, <strong>for a period of 10 years from the date of incorporation<\/strong>.<\/p>\n\n\n\n<p>This means a founder or promoter of a DPIIT-recognised startup can receive ESOPs during this 10-year window \u2014 subject to shareholder approval and the standard procedural requirements. This exemption is one of the most commercially significant provisions for early-stage founders and is widely underused simply because founders do not know it exists.<\/p>\n\n\n\n<p><strong>Independent directors<\/strong> cannot receive ESOPs under any circumstances \u2014 they are expressly excluded.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">ESOP vs SAR vs Phantom Stock \u2014 Choosing the Right Instrument<\/h2>\n\n\n\n<p>Many startups \u2014 particularly very early-stage companies \u2014 do not immediately implement a full ESOP. Understanding the alternatives helps founders choose the right instrument for their stage:<\/p>\n\n\n\n<figure class=\"wp-block-table\"><table class=\"has-fixed-layout\"><thead><tr><th>Instrument<\/th><th>What It Is<\/th><th>Shares Issued?<\/th><th>Tax at Exercise<\/th><th>Best For<\/th><\/tr><\/thead><tbody><tr><td><strong>ESOP (Employee Stock Option)<\/strong><\/td><td>Right to buy shares at predetermined price after vesting<\/td><td>Yes \u2014 actual shares issued on exercise<\/td><td>Perquisite tax on difference between FMV and exercise price<\/td><td>Companies ready for actual equity dilution<\/td><\/tr><tr><td><strong>SAR (Stock Appreciation Right)<\/strong><\/td><td>Cash payment equal to appreciation in share value<\/td><td>No \u2014 cash settlement<\/td><td>Taxed as salary\/bonus at time of payment<\/td><td>Companies wanting to avoid dilution; pre-ESOP stage<\/td><\/tr><tr><td><strong>Phantom Stock<\/strong><\/td><td>Cash\/notional units tracking share value<\/td><td>No \u2014 cash or notional settlement<\/td><td>Taxed as salary at time of payment<\/td><td>Very early stage, pre-funding, small teams<\/td><\/tr><tr><td><strong>ESOP over Sweat Equity<\/strong><\/td><td>Shares issued at discount\/free for non-cash contribution<\/td><td>Yes \u2014 shares issued directly<\/td><td>Capital gains from date of allotment<\/td><td>Founders\/key contributors at very early stage<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<p><strong>Important:<\/strong> SARs and Phantom Stock are not governed by Section 62(1)(b) or Rule 12 \u2014 they are not technically ESOPs under the Companies Act. They are contractual obligations to pay cash, treated as salary for tax purposes. This distinction matters enormously for compliance \u2014 SARs do not require the shareholder special resolution that ESOPs do, but they also do not give employees actual ownership.<\/p>\n\n\n\n<p>For startups that are VC-funded or planning to raise institutional money, a properly structured ESOP under Section 62(1)(b) is standard \u2014 investors expect to see it.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">The ESOP Option Pool \u2014 How Much Equity to Set Aside<\/h2>\n\n\n\n<p>Before implementing an ESOP, a startup must decide the size of its option pool \u2014 the total number of shares reserved for the ESOP scheme.<\/p>\n\n\n\n<p><strong>Standard market practice:<\/strong> 10\u201315% of fully diluted equity pre-Series A; often 15\u201320% by Series B as more senior hires require larger grants.<\/p>\n\n\n\n<p><strong>Two ways to create the pool:<\/strong><\/p>\n\n\n\n<p><strong>From existing shares (founder dilution):<\/strong> Founders transfer a portion of their existing shares into the ESOP pool. Existing shareholders are diluted proportionally. This is the more founder-unfriendly approach but is sometimes required by early investors.<\/p>\n\n\n\n<p><strong>Fresh share issuance:<\/strong> The company issues new shares for the ESOP pool. All existing shareholders \u2014 including founders and investors \u2014 are diluted equally. This is the more common approach for most Indian startups.<\/p>\n\n\n\n<p><strong>Investor negotiation dynamics:<\/strong> Most term sheets from VCs and angel investors include a &#8220;pre-money option pool&#8221; requirement \u2014 the ESOP pool must be created (diluting existing shareholders) before the investor&#8217;s investment is valued. This means founders bear most of the economic cost of the ESOP pool. Understanding this dynamic before signing term sheets is critical.<\/p>\n\n\n\n<p><strong>AOA check:<\/strong> Before creating an ESOP pool, verify that the company&#8217;s Articles of Association authorise the issuance of shares through an ESOP scheme. If not, the AOA must be amended by passing a special resolution at a General Meeting before the ESOP scheme can be approved.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Designing the ESOP Scheme Document<\/h2>\n\n\n\n<p>The ESOP scheme document (also called the ESOP policy) is the foundational legal document that governs every aspect of the plan. It must be approved by the Board and by shareholders in a Special Resolution.<\/p>\n\n\n\n<p><strong>What the ESOP scheme document must contain:<\/strong><\/p>\n\n\n\n<p><strong>1. Total pool size<\/strong> \u2014 the total number of options available for grant under the scheme<\/p>\n\n\n\n<p><strong>2. Eligible employees<\/strong> \u2014 the class of employees eligible to receive options (all employees, specific grades, specific roles, or identified individuals)<\/p>\n\n\n\n<p><strong>3. Vesting schedule<\/strong> \u2014 when and how options vest over time. Mandatory minimum: options cannot vest in less than 1 year from the date of grant. Industry standard: 4 years with a 1-year cliff.<\/p>\n\n\n\n<p><strong>4. Exercise price<\/strong> \u2014 the price at which an employee can purchase shares upon exercising vested options. For private companies, the exercise price:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Cannot be less than the face value of the share<\/li>\n\n\n\n<li>Is commonly set at fair market value (FMV) at the date of grant, or at a discount to FMV<\/li>\n\n\n\n<li>Must be determined by a registered valuer using the Discounted Cash Flow (DCF) method or the recent funding round price as a proxy<\/li>\n<\/ul>\n\n\n\n<p><strong>5. Exercise period<\/strong> \u2014 the window within which an employee can exercise vested options after vesting. Typically 30 days to 1 year after vesting, and a specific post-termination exercise window.<\/p>\n\n\n\n<p><strong>6. Lapse\/forfeiture conditions<\/strong> \u2014 what happens to unvested options when an employee leaves (they typically lapse), and any conditions under which vested but unexercised options lapse<\/p>\n\n\n\n<p><strong>7. Acceleration provisions<\/strong> \u2014 whether vesting accelerates in the event of a change of control, acquisition, or IPO (single-trigger vs double-trigger acceleration)<\/p>\n\n\n\n<p><strong>8. Anti-dilution protection<\/strong> \u2014 whether exercise price adjusts in the event of stock splits, bonus issues, or rights issues<\/p>\n\n\n\n<p><strong>9. Lock-in period<\/strong> \u2014 shares acquired through ESOP are subject to a lock-in of at least 1 year from allotment under Rule 12<\/p>\n\n\n\n<p><strong>10. Disclosure requirements<\/strong> \u2014 what information will be disclosed to employees, the Board&#8217;s Report, and the ROC<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">The Standard Vesting Schedule \u2014 India Practice<\/h2>\n\n\n\n<p>The most common vesting structure for Indian startups:<\/p>\n\n\n\n<p><strong>4-year vesting with 1-year cliff:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Year 1 (the cliff): 25% of options vest at the end of 12 months from the grant date \u2014 the employee receives nothing if they leave before 12 months<\/li>\n\n\n\n<li>Year 2\u20134: The remaining 75% vest monthly or quarterly in equal instalments<\/li>\n<\/ul>\n\n\n\n<p><strong>Example:<\/strong> 10,000 options granted on 1 June 2026<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>2,500 options vest on 1 June 2027 (cliff)<\/li>\n\n\n\n<li>208-209 options vest each month from July 2027 through June 2030<\/li>\n\n\n\n<li>All 10,000 options are fully vested by 1 June 2030<\/li>\n<\/ul>\n\n\n\n<p><strong>Alternative structures:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Milestone-based vesting:<\/strong> Options vest upon achievement of performance targets rather than purely time-based<\/li>\n\n\n\n<li><strong>Graded vesting:<\/strong> Different percentages vest each year (e.g., 20% Year 1, 25% Year 2, 30% Year 3, 25% Year 4)<\/li>\n\n\n\n<li><strong>Cliff + back-weighted:<\/strong> Larger cliff with smaller monthly vesting thereafter<\/li>\n<\/ul>\n\n\n\n<p>The Companies Act requires only that there be a minimum 1-year vesting period from the date of grant \u2014 the structure within that constraint is the company&#8217;s choice.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Step-by-Step: How to Implement an ESOP in an Indian Startup<\/h2>\n\n\n\n<h3 class=\"wp-block-heading\">Step 1 \u2014 Check and Amend the AOA<\/h3>\n\n\n\n<p>Review the Articles of Association to confirm they authorise ESOP issuance. If silent or restrictive, hold a General Meeting to amend the AOA by Special Resolution before proceeding. File the altered AOA with the ROC.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Step 2 \u2014 Approve the ESOP Scheme at a Board Meeting<\/h3>\n\n\n\n<p>Hold a Board Meeting with at least 7 days&#8217; notice. Pass a Board Resolution:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Approving the ESOP scheme document<\/li>\n\n\n\n<li>Authorising the convening of a General Meeting for shareholder approval<\/li>\n\n\n\n<li>Appointing a Compensation Committee (or Nomination &amp; Remuneration Committee) to administer the scheme<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Step 3 \u2014 Pass a Special Resolution at a General Meeting<\/h3>\n\n\n\n<p>Hold an Extraordinary General Meeting (EGM) \u2014 or pass a written resolution for private companies where permitted. Shareholders pass a <strong>Special Resolution<\/strong> (75% majority) approving:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>The ESOP scheme in its entirety<\/li>\n\n\n\n<li>The total pool size<\/li>\n\n\n\n<li>The classes of eligible employees<\/li>\n<\/ul>\n\n\n\n<p><strong>Additional separate resolutions required for:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Grants to employees of subsidiary, holding, or associate companies<\/li>\n\n\n\n<li>Grants to <strong>identified employees<\/strong> in any financial year that equal or exceed 1% of the issued capital of the company<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Step 4 \u2014 File Form MGT-14 Within 30 Days<\/h3>\n\n\n\n<p>File <strong>Form MGT-14<\/strong> with the Registrar of Companies within <strong>30 days<\/strong> of passing the Special Resolution. This files the special resolution and the ESOP scheme with the ROC as a matter of public record.<\/p>\n\n\n\n<p><strong>Penalty for late filing MGT-14:<\/strong> \u20b9500 per day up to \u20b95,00,000 for the company; additional liability for officers in default.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Step 5 \u2014 Obtain FMV Valuation for Exercise Price<\/h3>\n\n\n\n<p>Engage a <strong>registered valuer<\/strong> (under the Companies (Registered Valuers and Valuation) Rules, 2017) to determine the Fair Market Value of the company&#8217;s shares at the date of grant. The FMV determines the exercise price and is critical for tax calculations at the time of exercise.<\/p>\n\n\n\n<p>For early-stage startups pre-revenue: the recent funding round price is commonly used as a starting point, adjusted through the DCF model. For pre-funding startups: the NAV method or DCF with conservative assumptions applies.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Step 6 \u2014 Issue Grant Letters to Employees<\/h3>\n\n\n\n<p>Issue individual <strong>ESOP Grant Letters<\/strong> to each employee receiving an option grant. The grant letter must specify:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Number of options granted<\/li>\n\n\n\n<li>Grant date<\/li>\n\n\n\n<li>Exercise price<\/li>\n\n\n\n<li>Vesting schedule (start dates for each tranche)<\/li>\n\n\n\n<li>Exercise period<\/li>\n\n\n\n<li>Lapse\/forfeiture conditions<\/li>\n\n\n\n<li>Post-termination exercise window<\/li>\n<\/ul>\n\n\n\n<p>The grant letter is a legally binding document \u2014 both the company and the employee should retain signed copies.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Step 7 \u2014 Maintain SH-6 Register and File PAS-3 on Exercise<\/h3>\n\n\n\n<p><strong>Form SH-6<\/strong> \u2014 Maintain the Register of Employee Stock Options at the registered office, recording every grant, vesting, exercise, and lapse.<\/p>\n\n\n\n<p><strong>Form PAS-3<\/strong> \u2014 When employees exercise options and shares are actually allotted, file Form PAS-3 (Return of Allotment) with the ROC within <strong>30 days<\/strong> of the allotment.<\/p>\n\n\n\n<p>Failure to file PAS-3: Fine of \u20b91,000 per day (max \u20b925,000) on the company; additionally fine on each officer in default.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">ESOP Taxation in India \u2014 The Two-Stage Tax Event<\/h2>\n\n\n\n<p>ESOP taxation in India is a two-stage process. Understanding both stages is essential \u2014 both for structuring the ESOP (exercise price decisions) and for communicating tax implications to employees.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Stage 1 \u2014 Tax at Exercise (Perquisite Tax)<\/h3>\n\n\n\n<p>When an employee <strong>exercises<\/strong> their options and purchases shares, the difference between the <strong>Fair Market Value (FMV) on the exercise date<\/strong> and the <strong>exercise price<\/strong> paid is treated as a <strong>perquisite<\/strong> under Section 17(2) of the Income Tax Act, 1961.<\/p>\n\n\n\n<p>This perquisite is taxed as salary income at the employee&#8217;s applicable marginal income tax rate \u2014 which for senior employees in well-funded startups often means 30% plus surcharge and cess.<\/p>\n\n\n\n<p><strong>Formula:<\/strong> Perquisite Value = (FMV on exercise date) \u2212 (Exercise Price)<\/p>\n\n\n\n<p><strong>TDS obligation on employer:<\/strong> The company is required to deduct TDS on this perquisite value in the month of exercise. This is a critical compliance obligation \u2014 many startups miss it and face TDS defaults.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Startup Tax Deferral \u2014 Section 192 of the Income Tax Act<\/h3>\n\n\n\n<p>For employees of <strong>DPIIT-recognised startups<\/strong> (eligible startups), the Finance Act 2020 introduced a deferral of the perquisite tax on ESOPs:<\/p>\n\n\n\n<p>Tax on the perquisite is deferred to the <strong>earliest<\/strong> of:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>5 years<\/strong> from the end of the year of exercise<\/li>\n\n\n\n<li>The date the employee <strong>sells<\/strong> the shares<\/li>\n\n\n\n<li>The date the employee <strong>leaves<\/strong> the company<\/li>\n<\/ul>\n\n\n\n<p>This is a significant relief for employees of startups \u2014 they do not have to pay tax on an illiquid asset (private company shares they cannot easily sell) in the year of exercise. The TDS obligation on the employer is similarly deferred.<\/p>\n\n\n\n<p><strong>Eligibility:<\/strong> The startup must be DPIIT-recognised at the time of exercise, incorporated after 1 April 2016, and meet the DPIIT eligibility criteria (turnover below \u20b9100 crore in any of the last 10 years).<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Stage 2 \u2014 Capital Gains Tax on Sale<\/h3>\n\n\n\n<p>When the employee subsequently <strong>sells<\/strong> the shares, capital gains tax applies on the difference between the <strong>sale price<\/strong> and the <strong>FMV on the exercise date<\/strong> (which became the cost of acquisition for capital gains purposes).<\/p>\n\n\n\n<p><strong>For listed shares (after IPO):<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Short-term capital gains (STCG) \u2014 if sold within 12 months of allotment: taxed at <strong>15%<\/strong> under Section 111A<\/li>\n\n\n\n<li>Long-term capital gains (LTCG) \u2014 if sold after 12 months: taxed at <strong>12.5%<\/strong> on gains above \u20b91.25 lakh, under Section 112A (Budget 2024 rate)<\/li>\n<\/ul>\n\n\n\n<p><strong>For unlisted shares (before IPO):<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>STCG \u2014 if sold within 24 months of allotment: taxed at applicable slab rates<\/li>\n\n\n\n<li>LTCG \u2014 if sold after 24 months: taxed at <strong>12.5%<\/strong> without indexation (Budget 2024 rate)<\/li>\n<\/ul>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">The 2025 SEBI Amendment \u2014 Founder ESOPs Post-IPO<\/h2>\n\n\n\n<p>This is the most significant recent development in India&#8217;s ESOP landscape \u2014 and the one most guides have not yet covered adequately.<\/p>\n\n\n\n<p>On <strong>18 June 2025<\/strong>, SEBI approved an amendment to the SBEB Regulations. The formal notification was issued in <strong>September 2025<\/strong>. Before this amendment, founders who received ESOPs lost them upon the company&#8217;s IPO \u2014 creating a perverse incentive that discouraged founder participation in ESOP schemes.<\/p>\n\n\n\n<p>The SEBI amendment changes this: <strong>founders can now retain their ESOPs through and beyond the IPO<\/strong>, subject to the lock-in requirements applicable to founders&#8217; shares under the SEBI (Issue of Capital and Disclosure Requirements) Regulations.<\/p>\n\n\n\n<p><strong>Practical significance:<\/strong> This amendment makes it commercially viable for founder-participants in DPIIT-startup ESOP schemes to actually benefit from their grants through the liquidity event. Startups planning IPOs should now factor founder ESOP retention into their pre-IPO ESOP restructuring.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Common Mistakes Indian Startups Make With ESOPs<\/h2>\n\n\n\n<p><strong>Granting before shareholder approval:<\/strong> Grants made before the Special Resolution is passed are legally invalid. Employees who received such grants have no enforceable rights. All grants must follow the approved scheme.<\/p>\n\n\n\n<p><strong>Not checking the AOA:<\/strong> Many early-stage companies incorporate with template AOAs that do not include ESOP provisions. Attempting to implement an ESOP with a non-enabling AOA is invalid.<\/p>\n\n\n\n<p><strong>Setting exercise price below face value:<\/strong> The exercise price cannot be less than the face value of the share for unlisted companies. Setting it below face value violates Rule 12.<\/p>\n\n\n\n<p><strong>Missing the MGT-14 filing:<\/strong> The 30-day deadline from the date of the Special Resolution is frequently missed. Late MGT-14 filings attract per-day penalties.<\/p>\n\n\n\n<p><strong>Not maintaining SH-6:<\/strong> The Register of Employee Stock Options is a statutory register that must be maintained at the registered office. Failure to maintain it is a compliance gap that surfaces in funding due diligence and regulatory inspections.<\/p>\n\n\n\n<p><strong>Not issuing TDS for perquisite:<\/strong> Employers must deduct TDS on the perquisite at exercise. Many startups \u2014 especially those using informal ESOPs \u2014 do not do this, creating TDS defaults.<\/p>\n\n\n\n<p><strong>Not communicating tax implications to employees:<\/strong> An employee who exercises \u20b950 lakh worth of options and receives a \u20b915 lakh TDS deduction without prior warning becomes an unhappy employee. Tax planning communication is part of ESOP programme management.<\/p>\n\n\n\n<p><strong>Verbal or informal ESOP promises:<\/strong> &#8220;I&#8217;ll give you 1% of the company&#8221; without a formal grant letter, a shareholder-approved scheme, and proper documentation is not an ESOP \u2014 it is an unenforceable promise. Employees have taken startups to court over informal equity promises, and courts have generally been unsympathetic.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Frequently Asked Questions<\/h2>\n\n\n\n<p><strong>Q: What is an ESOP policy for startups in India?<\/strong><\/p>\n\n\n\n<p>A: An ESOP (Employee Stock Option Plan) policy is a formally documented scheme under which a startup grants eligible employees the right to purchase company shares at a predetermined exercise price after completing a vesting period. In India, ESOPs for private limited companies are governed by Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. They require Board approval, shareholder Special Resolution, and MGT-14 filing with the ROC within 30 days.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: Can founders receive ESOPs in Indian startups?<\/strong><\/p>\n\n\n\n<p>A: Generally, promoters and founders are excluded from ESOPs under Rule 12(1)(c) of the Companies (Share Capital and Debentures) Rules, 2014. However, DPIIT-recognised startups are exempt from this restriction for 10 years from the date of incorporation \u2014 allowing founders and promoters to receive ESOPs during this period, subject to shareholder approval. Additionally, a June 2025 SEBI amendment now allows founders to retain their ESOPs through the company&#8217;s IPO.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: What is the minimum vesting period for ESOPs in India?<\/strong><\/p>\n\n\n\n<p>A: Under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014, there must be a minimum vesting period of one year from the date of grant of options. The Companies Act does not prescribe a maximum vesting period or a mandatory cliff. Industry standard for Indian startups is a 4-year vesting schedule with a 1-year cliff \u2014 25% vesting at the end of year 1, with the remaining 75% vesting monthly or quarterly over years 2\u20134.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: How is ESOP taxed in India?<\/strong><\/p>\n\n\n\n<p>A: ESOP taxation in India occurs in two stages. First, when the employee exercises options, the difference between the fair market value on the exercise date and the exercise price is taxed as a perquisite (salary income) at marginal income tax rates \u2014 the employer must deduct TDS. Second, when the employee sells the shares, capital gains tax applies \u2014 LTCG at 12.5% (for listed shares held &gt;12 months; Budget 2024 rate) or applicable STCG rates. DPIIT-recognised startups&#8217; employees can defer the perquisite tax for up to 5 years from the exercise year.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: What is the ESOP tax deferral for DPIIT-recognised startups?<\/strong><\/p>\n\n\n\n<p>A: Under Section 192 of the Income Tax Act (as amended by Finance Act 2020), employees of DPIIT-recognised eligible startups can defer payment of perquisite tax on ESOP exercise to the earliest of: 5 years from the end of the year of exercise; the date they sell the shares; or the date they leave the company. This relieves employees from paying tax on illiquid private company shares in the year of exercise \u2014 a significant benefit that regular company employees do not receive.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: What forms must be filed with the ROC for an ESOP?<\/strong><\/p>\n\n\n\n<p>A: Three key ROC filings: (1) Form MGT-14 \u2014 within 30 days of the Special Resolution approving the ESOP scheme; (2) Maintain Form SH-6 \u2014 the Register of Employee Stock Options at the registered office, updated for every grant, vesting, exercise, and lapse; (3) Form PAS-3 \u2014 within 30 days of allotment when employees exercise options and shares are actually issued. Late filing of MGT-14 attracts \u20b9500 per day penalty; late PAS-3 attracts \u20b91,000 per day.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: How large should an ESOP pool be for an Indian startup?<\/strong><\/p>\n\n\n\n<p>A: Standard practice in India is 10\u201315% of fully diluted equity pre-Series A, often expanding to 15\u201320% by Series B as more senior hires require larger grants. Investors typically require an option pool to be created pre-money (before their investment is valued), which effectively means founders absorb most of the dilution cost. The pool size should be planned based on 3\u20135 year hiring projections and projected grant sizes for key roles.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><strong>Q: What is the difference between an ESOP and a SAR (Stock Appreciation Right)?<\/strong><\/p>\n\n\n\n<p>A: An ESOP under Section 62(1)(b) of the Companies Act gives employees the right to purchase actual shares at a fixed price \u2014 resulting in real equity ownership and dilution for the company. A SAR (Stock Appreciation Right) is a contractual right to receive cash equal to the appreciation in share value \u2014 no shares are issued, no dilution occurs, and the payment is taxed as salary. SARs do not require the shareholder special resolution that ESOPs do. ESOPs are standard for funded startups; SARs may be used at very early stages before formal equity structures are in place.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h2 class=\"wp-block-heading\">Structure Your ESOP Before the Next Funding Round<\/h2>\n\n\n\n<p>Investors in funded Indian startups expect to see a properly documented, shareholder-approved ESOP scheme before or at the funding round. ESOP documentation is a standard item in funding due diligence \u2014 informal equity promises, missing board resolutions, and unapproved schemes create deal risk and negotiating leverage loss.<\/p>\n\n\n\n<p>At TMZON, IP and compliance consultation includes ESOP advisory \u2014 from reviewing your Articles of Association for ESOP enablement to guiding you through the Board Resolution, Special Resolution, and ROC filing process alongside your trademark and IP protection.<\/p>\n\n\n\n<p><strong><a href=\"\/consultation\">Book a Compliance Consultation \u2192 TMZON<\/a><\/strong><\/p>\n\n\n\n<p>File all ROC forms including MGT-14 and PAS-3 through the official MCA portal:<\/p>\n\n\n\n<p><strong><a href=\"https:\/\/www.mca.gov.in\" target=\"_blank\" rel=\"noopener\">MCA21 Official Portal<\/a><\/strong><\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<p><em>This article is written for general informational purposes and does not constitute legal, financial, or tax advice. ESOP structuring involves complex legal and tax considerations \u2014 please consult a qualified Company Secretary, Chartered Accountant, or IP attorney for advice specific to your startup.<\/em><\/p>\n\n\n\n<p><em>Written by Arya Sharma, Advocate, Bombay High Court | Trademark Attorney<\/em><\/p>\n\n\n\n<p><em>\u00a9 2026 TMZON Corporate Services. All rights reserved.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>An ESOP (Employee Stock Option Plan) policy is a formally documented scheme under which a startup grants eligible employees the right \u2014 but not the obligation \u2014 to purchase company shares at a pre-determined price (exercise price) after completing a vesting period. In India, ESOPs for private limited companies are governed by Section 62(1)(b) of 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href=\"https:\/\/tmzon.com\/blog\/category\/startup-legal-basics\/\" rel=\"category tag\">Startup Legal Basics<\/a>","rttpg_excerpt":"An ESOP (Employee Stock Option Plan) policy is a formally documented scheme under which a startup grants eligible employees the right \u2014 but not the obligation \u2014 to purchase company shares at a pre-determined price (exercise price) after completing a vesting period. In India, ESOPs for private limited companies are governed by Section 62(1)(b) of&hellip;","_links":{"self":[{"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/posts\/890","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/comments?post=890"}],"version-history":[{"count":1,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/posts\/890\/revisions"}],"predecessor-version":[{"id":891,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/posts\/890\/revisions\/891"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/media\/893"}],"wp:attachment":[{"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/media?parent=890"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/categories?post=890"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/tmzon.com\/blog\/wp-json\/wp\/v2\/tags?post=890"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}