Understanding ESOPs in India: A Complete Guide for Employees and Startups

What Are ESOPs?

Employee Stock Option Plans (ESOPs) in India allow companies to reward and retain top talent by offering equity. Instead of high salaries, startups use ESOPs to let employees purchase company shares at a fixed price after a specific vesting period.

In simple terms, ESOPs help employees become part-owners of the company. This creates a direct link between performance and ownership, encouraging long-term commitment.

Why ESOPs Matter in India

In India, startups often face cash flow constraints. To attract and retain skilled professionals, they offer ESOPs as equity-based incentives.

Here’s why ESOPs are crucial:

• They retain core talent
• They boost employee motivation
• They lower attrition
• They create ownership-driven culture

Nasscom reports that over 75% of Indian unicorns have active ESOP schemes.

Legal Framework of ESOPs in India

Companies must follow specific laws when offering ESOPs:

• Companies Act, 2013 (Section 62(1)(b))
• SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 for listed firms

Who can receive ESOPs? Employees, non-independent directors, and officers of the company or its subsidiaries can be eligible.

What Should an ESOP Policy Include?

Companies must pass a special resolution to launch ESOPs. A valid ESOP plan should define:

• Grant Date: The date the option is offered
• Vesting Period: Time before options become exercisable (minimum 1 year in India)
• Exercise Price: Price employees pay to buy the shares
• Lock-in Period: Optional time restriction post-exercise

Taxation of ESOPs in India

Taxation happens in two phases:

1. During Exercise:

• The gap between the Fair Market Value (FMV) and exercise price is taxed as salary under “Income from Salaries.”

2. During Sale of Shares:

• Sale profits count as capital gains
• Short-term Gains: If shares are sold within 24 months (listed) or 36 months (unlisted)
• Long-term Gains: Taxed at 10% if gains exceed Rs. 1 lakh for listed shares

Budget 2025 Update: Recognized startups can now defer tax payments on ESOPs for up to 5 years or until employees sell shares or resign.

How Employees Benefit from ESOPs

ESOPs offer multiple financial advantages:

• Wealth Creation: Employees profit from the company’s success
• Affordable Entry: Shares are offered at low or nominal prices
• Deferred Tax: Especially valuable for startup employees

How Startups Can Launch ESOPs

Follow these steps to implement ESOPs:

1. Get board approval
2. Pass a special shareholder resolution
3. Decide ESOP pool size (usually 5–15% of total equity)
4. Draft the ESOP policy and agreement
5. Conduct share valuation via a Chartered Accountant in Mumbai
6. Allocate options and inform employees

CA Tip: Always consult experts in Chartered Accountant Services Mumbai to stay compliant and optimize tax treatment.

Mistakes Startups Should Avoid

To make ESOPs successful, avoid these common errors:

• Offering options without proper documentation
• Overlooking tax responsibilities
• Ignoring employee exit strategies
• Mispricing share valuations

Real-Life Examples: Zomato & Nykaa

Zomato allocated over Rs. 2,000 crore in ESOPs before its IPO. Nykaa followed suit. These strategic moves helped retain senior talent and strengthen IPO readiness.

Useful Links

• Inbound: LLP in India
• Outbound: SEBI ESOP Guidelines

Final Thoughts

ESOPs in India create win-win opportunities. Startups retain top performers, while employees share in the company’s growth. But success demands proper structuring, valuation, and tax planning.

At Makwana Sweta & Associates, we guide startups through every step of the ESOP journey—from policy design to valuation and taxation.

Looking for expert guidance? Reach out to our CA services in Mumbai team today.

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