In the corporate world compensation goes beyond just salary, businesses now offer ownership stakes to its employees. The most used instrument to offer the stake is Employees Stock Options (ESOPs) which can be direct or through trust. The popularity of ESOPs among new-age companies and startups had always been there, but this trend has moved to established companies too. Mahindra group rolled out ESOPs to its 23000 employees which included factory floor workers too signalling a shift. In FY 2024–25, over 3,000 startup employees benefited from ESOPs buy back with companies repurchasing vested stock options worth more than ₹1,450 crore (~$170 million).
SEBI has also announced plans to have a dedicated Pre IPO trading platform to unlock liquidity for ESOP holders and early Investors which further boosts this high-risk high-reward asset.

ESOP is a structured plan where the company sets aside certain pool of shares for distribution to employees over a period at an exercise price which could be face value or discount to the current market value based on performance, tenure and other criteria for the employee. The ESOPs are vested over a period such as quarterly, half yearly or yearly as discussed and approved mutually between the employee and company.

ESOPs can be granted to all employees of the company including whole time director except independent directors and Promoters of the company. ESOPs cannot be issued to a director who either himself or through any body corporate or through his relative holds more than ten per cent of the outstanding equity shares of the company, whether directly or indirectly. Exemption is provided to Startup registered with DPIIT from the above two restrictions upto 10 years of their registration. ESOPs can also be issued to employee or director of a subsidiary company in India or outside India, or holding company, or an associate company.

Steps for approval to ESOP Plan and issuance of grant of ESOP options to employees

1. Prepare the draft of ESOP Plan in accordance with the Companies Act, 2013 and Rules. This is most critical document which will cover all the terms such as exercise price & period, provision for lapse of options, treatment of vested and unvested options in case of resignation or termination, lock-in of shares, if any. It could also mention drag along rights meaning that in case of significant stake sale by Promoters/other shareholders, the ESOP grantee will be dragged along in sale. Considerable thought and care should be taken in drafting the plan to avoid conflict & complications later.
2. The ESOP Plan needs to be approved in Board and shareholders meeting
3.  Explanatory Statement shall be annexed to the notice of the shareholders meeting as per Section 102 disclosing as under:

• The total number of stock options which is to be granted,
• The identified class of employees who can participate in the ESOP,
• Requirements of vesting period of ESOP,
• Maximum period within which the options can be vested,
• The exercise price and process of exercise,
• The lock-in period, if any,
• The grant of the maximum number of options for an employee,
• The methods used by the company to value its options,
• The conditions of lapsing of the options vested in employees,
• A statement that the company will comply with the applicable accounting standards.

1. Pass Ordinary (in case of private company)/Special Resolution at the General Meeting to approve ESOP Plan.
2. File MGT-14 within 30 days of passing resolution at Board Meeting and General Meetings in case of special resolution
3. Maintain a ‘Register of Employee Stock Options’ in Form No.SH-6 and enter the particulars of the ESOP granted to the employees, directors or officers of the company.
4. If a private company wants to issue ESOP, then it should ensure that the Articles of Association (AOA) authorises for issuance of shares through ESOP. If the AOA does not authorise, then the company should first hold an Extraordinary General Meeting (Section 100 and SS-2) to alter the AOA to include the provisions of issuance of shares through ESOP.
5. Once the ESOP plan is approved, the company can issue ESOP options to its employees through Board resolution and issuing the employee ESOP grant letter. Minimum 1 year period between the grant and vesting of options is to be maintained.
6. The company can by special resolution vary the terms of the ESOP options not yet exercised by the employees
7. In case a company has issued ESOPs, certain additional disclosures are required to be made in the Board’s report such as Options granted, vested, exercised during the year, exercise price, variation in terms, if any.
8. In mature organisations with large ESOP plan and many employees, Trusts may be formed to hold the shares on behalf of the employees until they are vested.

Important points to be covered in ESOP Plan

• Non- transferability to a competitor
• To facilitate smooth stake sale later, it could also mention drag along rights meaning that in case of significant stake sale by Promoters/other shareholders, the ESOP grantee will be dragged along in sale.
• Rights of ESOP holders in case of bonus issuance, offering of rights shares, dividend
• Lapse of options in case not exercised in the exercise period, termination of employment
• Flexibility for deviation in offer terms for any particular employee can be mentioned in the grant letters
• Long leave definition
• Transferability of options in case of death
• Right of first refusal in case the option grantee wants to transfer its shares to any third party
• Purchase of vested options by the company

Taxation of ESOPs

Employees are not taxed at the time of grant of options but capital gain tax at the time of selling their vested shares will be charged at difference between sale price and fair market value on exercise date. Further, perquisite tax implication arises at the time of exercise.

ESOPs have effectively been used for long term retention of employees across all scale of organisations creating an ownership driven work environment and wealth creation for the employees. They also inculcate positive culture and loyalty in employees. Major startups like Flipkart, Paytm, Ola, Zomato, and Swiggy have utilized ESOPs strategically to build world-class teams and offer attractive compensation packages, facilitating rapid growth and market disruption.

Akansha Rathi and Associates (ARACS), Company Secretary Firm in Navi Mumbai is engaged into compliance related services. We have a team of experts who not only possess required skills and experience but also have worked in complex business environment and were engaged in providing complex solutions in terms of providing related Compliance services to our clients.