Employee Stock Option Plan (ESOP) – Legal Framework, Process And Key Compliance Points For Unlisted Public And Private Limited Companies
Summary: Article outlines the legal framework, process and compliance requirements for Employee Stock Option Plans (ESOPs)/Employee Stock Option Schemes (ESOS) by unlisted public and private limited companies under Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. It explains eligibility, exclusions, startup exemptions, preliminary requirements relating to the Articles of Association and authorised share capital, and the different shareholder approval requirements for unlisted public and private companies, including the MCA exemption notification G.S.R. 464(E) dated 5 June 2015. The content describes the step-by-step process covering Board approval, shareholder approval, grant, vesting, exercise, allotment, maintenance of Form SH-6, filing of MGT-14 and PAS-3, mandatory disclosures, ongoing compliance, direct and trust routes, accounting treatment under Ind AS 102 and the ICAI Guidance Note, taxation at exercise and sale, treatment of lapse and exit events, exercise price requirements, FEMA compliances for grants to foreign employees, RBI filings including the ESOP Reporting Form and Form FC-GPR, and a consolidated compliance checklist for implementation and continuing statutory compliance.
1. Introduction and Scope
An Employee Stock Option Plan (ESOP), referred to under the Companies Act, 2013 as an “Employee Stock Option Scheme” (ESOS), is an employee benefit mechanism under which a company grants its employees, directors and officers an option — not an obligation — to purchase or subscribe to the company’s shares at a future date, at a price fixed in advance. It is a deferred ownership instrument: no shares are allotted at the time of grant; shareholder rights arise only when the option vests, is exercised, and shares are actually allotted.
This note sets out the legal framework, eligibility, step-by-step procedure, disclosures and continuing compliance obligations applicable to the issue of ESOPs by unlisted public companies and private limited companies in India. It does not cover the additional SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 requirements applicable to listed companies, save where referenced for contrast.
2. Statutory Framework
The legal basis for issue of ESOPs by Indian companies rests on two interconnected instruments:
- Section 62(1)(b) of the Companies Act, 2013 — the enabling provision. It permits a company having share capital to offer further shares to its employees under a scheme of employees’ stock option, subject to shareholder approval and prescribed conditions. This is one of three routes for further issue of share capital under Section 62(1) — the other two being rights issues (Section 62(1)(a)) and preferential allotment (Section 62(1)(c)).
- Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 — the operational rule. It prescribes the detailed conditions: eligibility and exclusions, minimum vesting period, mandatory disclosures in the explanatory statement, and the requirement to maintain a Register of Employee Stock Options in Form SH-6.
Section 62(1)(b) and Rule 12 operate together and both must be satisfied — the statutory authority alone does not permit issue without compliance with the Rule 12 conditions, and vice versa. Section 2(37) of the Act defines “employees’ stock option” in materially the same terms.
Note: For listed companies, the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 and SEBI (LODR) Regulations, 2015 apply in addition to the above — including a compensation committee, merchant banker/secretarial auditor certifications, and stock-exchange disclosure timelines. These are outside the scope of this note, which is confined to unlisted public and private companies.
3. Key Definitions
| Term | Meaning |
| Option | The right (not obligation) given to an employee to purchase or subscribe, at a future date, to shares offered by the company at a pre-determined price. |
| Employee Stock Option Scheme (ESOS) | The scheme under Section 62(1)(b) approved by shareholders, under which options are granted to eligible employees/directors, subject to Rule 12 conditions. |
| Vesting period | The time frame between grant of the option and the date the employee becomes entitled to exercise it — minimum one year under Rule 12. |
| Exercise period | The period, commencing after vesting, within which the employee may apply for shares against vested options. |
| Exercise price | The price payable by the employee to exercise the vested option — cannot be less than the face value of the share. |
| Grant | The stage at which the option is offered/issued to the employee — creates only a contractual/statutory entitlement, not shareholding. |
| Allotment | The stage, following exercise, at which shares are actually issued — shareholder rights (voting, dividend) arise only from this point. |
4. Preliminary Requirements Before Launching a Scheme
1. Articles of Association (AoA): The AoA must expressly authorise the issue of shares to employees under an ESOP scheme. If silent, the AoA must first be altered by special resolution in a general meeting before the ESOP approval process is undertaken.
2. Authorised share capital: The authorised capital under the Memorandum of Association must be sufficient to cover the proposed ESOP pool together with the existing issued capital. If insufficient, the MOA must be amended (special resolution, stamp duty and RoC filing) before the scheme can be operationalised.
5. Eligibility — Who Can and Cannot Be Granted Options
5.1 Eligible categories (Rule 12(1))
- A permanent employee of the company, working in India or outside India.
- A director of the company — whole-time director or not but excluding an independent director.
- A permanent employee or director of a subsidiary, holding, or company, in India or outside India.
An employee who has completed probation is generally treated as “permanent” for this purpose, as the term is not separately defined in the Act. Employees engaged on fixed-term contracts (e.g., 3-4 year contracts) are eligible if they are on the company’s payroll. A scheme may also validly cover future employees who join after the scheme is approved.
5.2 Persons excluded
- A promoter, or a person belonging to the promoter group.
- A director who, himself, through a relative, or through a body corporate, holds more than 10% of the company’s outstanding equity shares, directly or indirectly.
- An independent director (excluded in all cases, to preserve independence from management).
5.3 Startup exemption
Where the company is recognised as a “startup” under the DPIIT Startup India framework ( G.S.R. 127(E), dated 19th February, 2019 issued by the Department for Promotion of Industry and Internal Trade), the promoter/10%-holder exclusions above do not apply for 10 years from the date of incorporation, provided annual turnover has not exceeded ₹100 crore in any financial year since incorporation. This allows founder-promoters of an eligible startup to also participate in the ESOP pool during this window.
6. Shareholder Approval — Private Company vs Unlisted Public Company
This is a critical point of distinction for the two entity types covered by this note:
| Aspect | Unlisted Public Company | Private Company |
| Governing requirement | Section 62(1)(b) — special resolution | MCA exemption notification G.S.R. 464(E) dated 5 June 2015 |
| Resolution required for the ESOP scheme | Special resolution (votes in favour ≥ 3× votes against) | Ordinary resolution (simple majority) suffices; special resolution may still be voluntarily adopted |
| Notice period for general meeting | At least 21 clear days | At least 21 clear days |
| MGT-14 filing | Mandatory — within 30 days of the special resolution | Required only if a special resolution is actually passed |
| AoA amendment (if required) | Special resolution | Special resolution (no relaxation, even for private companies) |
Note: Even where a private company avails of the ordinary-resolution route for the ESOP scheme itself, any accompanying alteration of the Articles of Association still requires a special resolution.
Separate shareholder approval (a distinct resolution) is additionally required where: (a) options are proposed to be granted to employees/directors of a subsidiary or holding company; or (b) the grant to any identified employee in a single year equals or exceeds 1% of the company’s issued capital (excluding outstanding warrants/conversions) at the time of grant.
7. Step-by-Step Procedure
Step 1 — Board approves the draft scheme
- Nomination & Remuneration Committee (where applicable) identifies eligible employees/directors and lays down eligibility criteria; the Board may authorise the NRC to also act as the compensation committee for ESOP purposes.
- Draft ESOP scheme document is prepared, covering: option pool size, eligible categories, vesting conditions and schedule, exercise price/pricing methodology, exercise period, lock-in (if any), and lapse conditions. A valuation report (Chartered Accountant / SEBI-registered merchant banker) is advisable to support the exercise price, though not statutorily mandatory under Section 62(1)(b) for unlisted companies.
- Notice of Board meeting, with the draft resolution, is circulated to all directors at least 7 days in advance.
- At the Board meeting: the scheme and pricing are approved; the notice and explanatory statement for the general meeting are approved; date, time and venue for the general meeting are fixed; a scheme administrator may be designated.
- Draft minutes of the Board meeting are circulated to all directors within 15 days of the meeting.
- Form MGT-14 is filed with the RoC for the Board resolution, where applicable.
Step 2 — Shareholders approve the scheme
- Notice of the general meeting, together with the explanatory statement (Section 102) containing the disclosures listed in Section 8 below, is sent to directors, auditors, shareholders and the secretarial auditor at least 21 clear days before the meeting (with additional buffer where sent by post).
- The company convenes the general meeting and passes the resolution — special resolution for an unlisted public company; ordinary resolution (or special resolution, if the company chooses) for a private company, per the discussion at Section 6.
- A separate special/ordinary resolution (as applicable) is passed for any 1%-threshold grant or subsidiary/holding-company grant identified above.
- Form MGT-14 is filed with the RoC within 30 days of passing a special resolution, along with the requisite documents (explanatory statement, certified copy of resolution, altered AoA if applicable).
Step 3 — Grant of options
- The Board convenes to grant options to eligible employees/directors and passes the grant resolution.
- Individual grant letters are issued to each optionee, recording the number of options, vesting schedule, exercise price and exercise period. The grant letter is distinct from the scheme document — the scheme is the framework; the grant letter formalises the individual award.
- The company maintains a Register of Employee Stock Options in Form No. SH-6, recording particulars of every grant.
Step 4 — Vesting
- A minimum of one year must elapse between the date of grant and the date of first vesting (the statutory “cliff”). Beyond the cliff, vesting may be time-based, performance-based, or a graded combination (e.g., 25% per year over four years), as the scheme provides.
- Until shares are actually issued on exercise, the optionee has no right to vote, receive dividend, or otherwise enjoy shareholder rights merely by virtue of the option.
Step 5 — Exercise and allotment
- On vesting, the employee may exercise vested options within the exercise window by applying for shares and paying the exercise price.
- The Board convenes to allot shares against options validly exercised, records the allotment in a Board resolution, updates the register of members, and enters the exercise/allotment particulars in the SH-6 register.
- Form PAS-3 (Return of Allotment) is filed with the RoC recording the shares, allottees, and consideration received; Form MGT-14 is also filed for the allotment resolution where a special resolution basis applies.
- A lock-in on the allotted shares may be specified by the company under the scheme, if considered necessary.
8. Mandatory Disclosures in the Explanatory Statement (Section 102)
The explanatory statement annexed to the notice convening the general meeting must contain all the material information and disclosures prescribed under Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014, to enable shareholders to make an informed decision.
9. Key Ongoing Compliance Requirements
- Upon implementation of an ESOP scheme, the company must ensure ongoing compliance with the applicable provisions of the Companies Act, 2013 and the Companies (Share Capital and Debentures) Rules, 2014, including maintenance of statutory records, regulatory filings, disclosures and other continuing compliance requirements.
10. Direct Route vs Trust Route
10.1 Direct route
The company issues options directly to eligible employees; on exercise, fresh shares are allotted directly to the employee, who becomes a shareholder of the company. This is the simpler and more commonly used route for private companies and unlisted public companies.
10.2 Trust route
A separate employee welfare trust is set up to hold shares (fresh issue or otherwise) for the benefit of employees; on exercise, the trust transfers shares to the employee. Companies may provide money to such a trust for purchase/subscription of shares, subject to Rule 16 conditions noted in Section 9 above — including special resolution approval, valuation by a registered valuer where shares are unlisted, and the 5% ceiling on paid-up capital and free reserves. Section 67 of the Act permits a company to provide financial assistance for purchase of its own shares specifically where this is for the purposes of an ESOP.
11. Accounting Treatment
Grant of ESOPs creates a compensation expense that must be recognised in the company’s financial statements — this is not optional. Companies applying Indian Accounting Standards (Ind AS) follow Ind AS 102 (Share-Based Payments); companies applying Indian GAAP follow the ICAI Guidance Note on Accounting for Share-Based Payments.
Under Ind AS 102, the fair value of options is estimated at the grant date using an option-pricing model (typically Black-Scholes or Binomial), and the aggregate fair value is expensed over the vesting period. Where vesting is graded (e.g., 25% per year over four years), each tranche is treated as a separate grant with its own expense-recognition timeline. A larger pool at a lower exercise price results in a correspondingly higher charge to the profit and loss account — a point that should be flagged to promoters ahead of fundraising rounds and statutory audit.
12. Taxation of ESOPs
ESOPs carry a dual tax incidence in the hands of the employee:
12.1 At the time of exercise
The difference between the Fair Market Value (FMV) of the shares on the date of exercise and the exercise price paid is treated as a perquisite and taxed at the employee’s applicable income-tax slab rate, under the head ‘Salaries’. Where the ESOPs are offered to directors, this perquisite value also forms part of managerial remuneration for the purposes of Sections 197 and 198 of the Companies Act, 2013.
12.2 At the time of sale of shares
On subsequent sale, the difference between the sale price and the FMV as on the date of exercise is taxed as capital gains — long-term if the shares are held for more than 12 months from the date of exercise, and short-term otherwise.
12.3 DPIIT-recognised startups — deferral of TDS
For eligible startups, tax on the perquisite is not required to be deducted/paid in the year of exercise itself. The employer’s TDS obligation is deferred to the earliest of: (i) five years from the date of grant; (ii) the date the employee sells the shares; or (iii) the date the employee ceases to be an employee of the company.
13. Lapse and Exit Events
The scheme should clearly specify treatment on resignation, termination, retirement and death. As a general default, unvested options lapse on resignation or termination unless the scheme expressly provides otherwise; vested (and sometimes unvested) options may, in the case of death, be dealt with in favour of legal heirs as the scheme provides. Precise drafting of these clauses at the scheme stage is important to avoid disputes at exit.
14. Exercise Price — Flexibility and Limits
The company has full commercial freedom in fixing the exercise price — it may be set at a discount to, at, or at a premium over the prevailing fair market value, and different prices may be fixed for different employees or classes of employees on a discretionary basis. The only statutory floor is that the exercise price cannot be less than the face (nominal) value of the share. A registered valuer’s certificate is not mandatory for pricing under Section 62(1)(b) itself (unlike the position under Rule 16 for the trust route), but the scheme and explanatory statement must clearly disclose the price or the pricing formula.
15. FEMA Aspects — Grants to Foreign Employees
Where options are granted to employees based outside India, FEMA considerations arise. Investment received from the foreign employee on exercise is treated as FDI and is subject to the applicable entry route (automatic or approval), sectoral cap, investment limits and pricing guidelines. Where an Indian holding company grants ESOPs to employees of its foreign subsidiary located in specified land-bordering countries (e.g., Pakistan, China, Bhutan, Nepal, Myanmar, Hong Kong, Macao, Taiwan), prior RBI approval is mandatory even where the grant would otherwise fall under the automatic route.
- At the time of grant of options — filing of the ESOP Reporting Form with the RBI.
- At the time of issue and allotment of capital instruments on exercise — filing of Form FC-GPR.
16. Consolidated Compliance / Filing Checklist
| # | Action / Filing | Form / Instrument | Timeline |
| 1 | Amend AoA to enable ESOP issue (if not already enabling) | Special resolution + MGT-14 | Before scheme approval |
| 2 | Board approves draft scheme, pricing, and GM notice | Board resolution | Notice ≥ 7 days before Board meeting |
| 3 | Circulate draft Board minutes | Draft minutes | Within 15 days of Board meeting |
| 4 | File Board resolution with RoC, where applicable | MGT-14 | As applicable |
| 5 | Notice of general meeting with explanatory statement | Section 102 statement | ≥ 21 clear days before GM |
| 6 | Shareholders approve scheme | Special resolution (public) / Ordinary resolution (private) | At the general meeting |
| 7 | File resolution with RoC | MGT-14 | Within 30 days of special resolution |
| 8 | Board grants options; issue grant letters | Board resolution + grant letters | Post shareholder approval |
| 9 | Maintain options register | Form SH-6 | Continuous, updated per grant |
| 10 | Vesting of options | Per scheme schedule | Minimum 1 year from grant |
| 11 | Exercise of vested options by employee | Exercise application + payment | Within exercise window |
| 12 | Board allots shares on exercise | Board resolution | On valid exercise |
| 13 | File return of allotment | PAS-3 | Within 30 days of allotment |
| 14 | Update register of members; SH-6 update | Statutory registers | On allotment |
| 15 | Disclose ESOP particulars in Board’s Report | Board’s Report | Annually, for the relevant FY |
18. Conclusion
An ESOP is not merely an employee incentive—it is a regulated share-capital transaction governed by Section 62(1)(b) of the Companies Act, 2013 read with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Its successful implementation requires proper corporate approvals, statutory disclosures, timely RoC filings, compliance with the minimum vesting period and maintenance of prescribed records. A well-structured and legally compliant ESOP not only enhances employee ownership but also withstands regulatory scrutiny during audits, due diligence and investment transactions.
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Disclaimer : This note has been prepared by M/s. Ronak Jhuthawat & Co., Company Secretaries, for general informational purposes only, based on the provisions of the Companies Act, 2013, the Companies (Share Capital and Debentures) Rules, 2014, applicable SEBI regulations (where relevant), and other applicable laws as on the date of this note. The contents are intended to provide a general overview of the legal framework governing Employee Stock Option Plans (ESOPs) and do not constitute legal, tax, accounting, or financial advice. Readers are advised to seek professional advice before acting on the basis of this note. While due care has been taken in its preparation, M/s. Ronak Jhuthawat & Co. shall not be liable for any loss arising from reliance on this note.
Author: CS Ronak Jhuthawat | Company Secretary | Partner, Ronak Jhuthawat & Co. | compliancerjac@gmail.com
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