Employee Stock Options Plan - ESOP

An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company. ESOPs give the sponsoring company, the selling shareholder, and participants receive various tax benefits, making them qualified plans. Companies often use ESOPs as a corporate-finance strategy to align the interests of their employees with those of their shareholders.

ESOPs Provide a Variety of Significant Tax Benefits for Companies and Their Owners. ESOP Rules Are Designed to Assure the Plans Benefit Employees Fairly and Broadly

Key Takeaways

  • An employee stock ownership plan gives workers ownership interest in the company.
  • ESOP is usually formed to allow employees the opportunity to buy stock in a closely held company to facilitate succession planning.
  • ESOPs encourage employees to do what's best for shareholders since the employees themselves are shareholders and provide companies with tax benefits, thus incentivizing owners to offer them to employees.
  • Companies typically tie distributions from the plan to vesting.
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About This Plan

In this plan we shall help you in Issuing ESOP for your organization.

Created by potrace 1.15, written by Peter Selinger 2001-2017


Varies from case to case

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Services Covered
Who Should Buy
How It's Done
Documents Required
Services Covered

  • Drafting of Documentation
  • Filing of Forms with departments
Who Should Buy

  • Companies who want to issue ESOPS
How It's Done
  • Purchase the plan
  • Provide details required
  • Get support in preparing and arranging the documents
  • TAXAJ files Forms and necessary agreements on your behalf
Documents Required

  1. Depends upon case to case basis.

A well established method to boost your Employees Morale!

To Whom Can The ESOP Be Issued?

Rule 12(1) of Companies (Share Capital and Debentures) Rules, 2014 states that ESOP can be issued to the following employees-

  • A permanent employee of the company who is working in India or outside India.
  • A Director of the company, including a whole-time or part-time director but not an independent director.
  • A permanent employee or director of a subsidiary company in India or outside India, or holding company, or an associate company.

A company cannot issue ESOP to the following employees-

  • An employee who is belonging to the promoter group or is a promoter of the company.
  • 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.

However, the above two conditions do not apply to Startup Companies for a period of ten years from the date of its incorporation.

Process Of Issue Of ESOP

Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 (“Rules”) governs the issuance of ESOP. The procedure for issuance of ESOP under the Rules is similar to that of the procedure under the Securities and Exchange Board of India Employee Stock Option Scheme Guidelines for listed companies. The process for issuing ESOP by a company are:

  • Prepare the draft of ESOP in accordance with the Companies Act, 2013 and Rules.
  • Prepare the notice for the board meeting along with the draft resolution to be passed in the board meeting.
  • Send the notice of the board meeting to all the directors at least seven days before the meeting.
  • Pass the resolution for the issuance of shares through ESOP, determine the price of shares to be issued pursuant to ESOP and fix time and date and approve for calling the general meeting to pass a special resolution for issuing ESOP.
  • Send the draft minutes of the board meeting to all the directors within fifteen days of its conclusion and file the MGT-14 form with the Registrar of Companies of passing the board resolution.
  • Send notice of the general meeting to all the directors, auditors, shareholders and secretarial auditors of the company at least before twenty-one days of the date of the meeting.
  • Pass the special resolution for the issuance of shares under the ESOP to the employees, directors and officers of the company in the general meeting.
  • File MGT-14 form with the Registrar of Companies within thirty days of passing the special resolution in the general meeting along with the documents.
  • Send options to the employees, directors and officers of the company for purchasing shares under ESOP.
  • 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.
  • If a private company wants to issue ESOP, then it should ensure that the Articles of Association (AoA) authorise for issuance of shares through ESOP. If the AoA does not authorise, then the company should first hold an extraordinary general meeting to alter the AoA to include the provisions of issuance of shares through ESOP and then proceed with holding the board meeting for the passing of the resolution and getting the shareholder’s approval for ESOP Scheme.

Allotment of ESOP

There are three terms that are mainly focused on the time of issuance of shares through ESOP to the employees. They are as follows-

  • Grant: Grant means the issue of stocks to the employees. It means informing the employee that he is eligible for ESOP. The company will have the freedom to determine the exercise price while providing the option of ESOP to the employees.
  • Vest: Vest means the right of the employees to apply for the shares granted to them. There shall be a minimum of one year between the grant of option and vesting of option for the ESOP scheme.
  • Exercise: The exercise period is where the employees can exercise the option of buying the shares. The company will have the freedom to specify the lock-in period for the shares issued (if any) after the exercise of the option. The employees will not have the right to receive any dividend or to vote or enjoy the advantages of a shareholder in respect of the ESOP granted to him until the shares are issued on exercise of his option.

Disclosures To Be Made While Issuing ESOP

The company should make the following disclosures in the explanatory statement annexed to the notice for passing the special resolution for the issuance of ESOP-

  • 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.

Understanding Employee Stock Ownership Plans (ESOP)

An ESOP is usually formed to facilitate succession planning in a closely held company by allowing employees the opportunity to buy stock. ESOPs are set up as trust funds and can be funded by companies putting newly issued shares into them, putting cash in to buy existing company shares, or borrowing money through the entity to buy company shares. ESOPs are used by companies of all sizes including a number of large publicly traded corporations.

Since ESOP shares are part of the employees' remuneration package, companies can use ESOPs to keep plan participants focused on corporate performance and share price appreciation. By giving plan participants an interest in seeing the company's stock perform well, these plans supposedly encourage participants to do what's best for shareholders, since the participants themselves are shareholders.

Why ESOP ?

Organizations often use Employee stock ownership plans as a tool for attracting and retaining high-quality employees. Organizations usually distribute the stocks in a phased manner. For instance, a company might grant its employees the stocks at the close of the financial year, thereby offering its employees an incentive for remaining with the organization for receiving that grant. Companies offering ESOPs have long-term objectives. Not only companies wish to retain employees for a long-term, but also intend making them the stakeholders of their company. Most of the IT companies have alarming attrition rates, and ESOPs could help them bring down such heavy attrition Start-ups offer stocks for attracting talent. Often such organizations are cash-strapped and are unable to offer handsome salaries. But by offering a stake in their organization, they make their compensation package competitive.

ESOP Rules

An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan. Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits. The 2017 tax bill limits net interest deductions for businesses to 30% of EBITDA (earnings before interest, taxes, depreciation, and amortization) for four years, at which point the limit decreases to 30% of EBIT (not EBITDA). In other words, starting in 2022, businesses will subtract depreciation and amortization from their earnings before calculating their maximum deductible interest payments.

New leveraged ESOPs where the company borrows an amount that is large relative to its EBITDA may find that their deductible expenses will be lower and, therefore, their taxable income may be higher under this change. This change will not affect 100%-ESOP owned S corporations because they don't pay tax.

Shares in the trust are allocated to individual employee accounts. Although there are some exceptions, generally all full-time employees over 21 participate in the plan. Allocations are made either on the basis of relative pay or some more equal formula. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting. Employees must be 100% vested within three to six years, depending on whether vesting is all at once (cliff vesting) or gradual.

When employees leave the company, they receive their stock, which the company must buy back from them at its fair market value (unless there is a public market for the shares). Private companies must have an annual outside valuation to determine the price of their shares. In private companies, employees must be able to vote their allocated shares on major issues, such as closing or relocating, but the company can choose whether to pass through voting rights (such as for the board of directors) on other issues. In public companies, employees must be able to vote all issues.

Uses for ESOP

  1. To buy the shares of a departing owner: Owners of privately held companies can use an ESOP to create a ready market for their shares. Under this approach, the company can make tax-deductible cash contributions to the ESOP to buy out an owner's shares, or it can have the ESOP borrow money to buy the shares (see below).
  2. To borrow money at a lower after-tax cost: ESOPs are unique among benefit plans in their ability to borrow money. The ESOP borrows cash, which it uses to buy company shares or shares of existing owners. The company then makes tax-deductible contributions to the ESOP to repay the loan, meaning both principal and interest are deductible.
  3. To create an additional employee benefit: A company can simply issue new or treasury shares to an ESOP, deducting their value (for up to 25% of covered pay) from taxable income. Or a company can contribute cash, buying shares from existing public or private owners. In public companies, which account for about 5% of the plans and about 40% of the plan participants, ESOPs are often used in conjunction with employee savings plans. Rather than matching employee savings with cash, the company will match them with stock from an ESOP, often at a higher matching level.

Upfront Costs and Distributions

Companies often provide employees with such ownership with no upfront costs. The company may hold the provided shares in a trust for safety and growth until the employee retires or resigns from the company. Companies typically tie distributions from the plan to vesting—the proportion of shares earned for each year of service.

After becoming fully vested, the company "purchases" the vested shares from the retiring or resigning employee. The money from the purchase goes to the employee in a lump sum or equal periodic payments, depending on the plan. Once the company purchases the shares and pays the employee, the company redistributes or voids the shares. Employees who resign or retire cannot take the shares of stock with them, only the cash payment. Fired employees often only qualify for the amount they have vested in the plan.

Employee-owned corporations are companies with majority holdings held by their own employees. These organizers are like cooperatives, except that the company does not distribute its capital equally. Many of these companies only provide voting rights to particular shareholders. Companies may also give senior employees the benefit of more shares compared to new employees.

ESOP and Other Forms of Employee Ownership

Stock ownership plans provide packages that act as additional benefits for employees to prevent hostility and keep a specific corporate culture that company managements want to maintain.

Other versions of employee ownership include direct-purchase programs, stock options, restricted stock, phantom stock, and stock appreciation rights. Direct-purchase plans let employees purchase shares of their respective companies with their personal after-tax money. Some countries provide special tax-qualified plans that let employees purchase company stock at discounted prices. 

Restricted Stock, Stock Options, and Phantom Stock

Restricted stock gives the employees the right to receive shares as a gift or a purchased item after meeting particular restrictions, such as working for a specific period or hitting specific performance targets. Stock options provide employees with the opportunity to buy shares at a fixed price for a set period, while phantom stock provides cash bonuses for good employee performance.

These bonuses equate to the value of a particular number of shares. Stock appreciation rights give employees the right to raise the value of an assigned number of shares. Companies usually pay these shares in cash.

Problems related to ESOP for Employers

It’s easy to pitch the benefits of ESOPs for the companies considering the liquidity and succession alternatives. However, there are good reasons not to go for ESOPs. Employee stock ownership plans have complex rules and need significant oversight. Although outsourcing this function to external advisors and ESOP TPA (Third Party Administration) firms could manage it, the ESOP company requires some internal personnel for championing this program. In case a company doesn’t have the staff to do the ESOP work properly, they could risk issues and potential violations. Once the ESOPs are established, the company needs a proper administration including the third-party administration, trustee, valuation, legal costs. Company owners and the management must be aware of the ongoing costs. In case the cash flow which is dedicated to ESOPs limits the cash available for reinvesting in the business over a long-term, the ESOP scheme isn’t a good fit for such a company. For companies requiring significant additional capital for carrying on business operations, they must avoid ESOPs. The ESOP schemes use the cash flow of the company for funding purchase of shares from its shareholders. In case a company requires the funds for additional working capital or capital expenditures, the ESOP transactions would compete with this necessary requirement, creating a crisis situation for the management.

Major Tax Benefits

Employee stock ownership plans is considered as perquisites with respect to taxation. On the other hand, for an employee, ESOPs are taxed at two below-mentioned instances – While exercising – in form of a prerequisite. When an employee exercises his option, the difference between Fair Market Value (FMV) as on date of exercise and the exercise price is taxed as a perquisite. While selling – in the form of capital gain. An employee might sell his shares after buying them. In case he sells these shares at a price higher than FMV on the exercise date, he would be liable for capital gains tax. The capital gains would be taxed depending on the period of holding. This period is calculated from the date of exercise up to the date of sale. Equity shares which are listed on the recognized stock exchange are considered as long-term capital if they’re held for more than 12 months i.e. 1 year. In case the shares are sold within 12 months, these are then considered as short term. Presently, long-term capital gains (LTCG) on the listed equity shares are exempt from tax. However as per the recent amendments in Budget 2018, Sale of equity shares that are held for more than a year on or after 1st April 1, 2018 would attract tax at the rate of 10% and cess of 4%. Short-term capital gains (STCG) are taxed at a rate of 15%.

ESOPs have a number of significant tax benefits, the most important of which are:

  1. Contributions of stock are tax-deductible: That means companies can get a current cash flow advantage by issuing new shares or treasury shares to the ESOP, albeit this means existing owners will be diluted.
  2. Cash contributions are deductible: A company can contribute cash on a discretionary basis year-to-year and take a tax deduction for it, whether the contribution is used to buy shares from current owners or to build up a cash reserve in the ESOP for future use.
  3. Contributions used to repay a loan the ESOP takes out to buy company shares are tax-deductible: The ESOP can borrow money to buy existing shares, new shares, or treasury shares. Regardless of the use, the contributions are deductible, meaning ESOP financing is done in pretax dollars.
  4. Sellers in a C corporation can get a tax deferral: In C corporations, once the ESOP owns 30% of all the shares in the company, the seller can reinvest the proceeds of the sale in other securities and defer any tax on the gain.
  5. In S corporations, the percentage of ownership held by the ESOP is not subject to income tax at the federal level (and usually the state level as well): That means, for instance, that there is no income tax on 30% of the profits of an S corporation with an ESOP holding 30% of the stock, and no income tax at all on the profits of an S corporation wholly owned by its ESOP. Note, however, that the ESOP still must get a pro-rata share of any distributions the company makes to owners.
  6. Dividends are tax-deductible: Reasonable dividends used to repay an ESOP loan, passed through to employees, or reinvested by employees in company stock are tax-deductible.
  7. Employees pay no tax on the contributions to the ESOP, only the distribution of their accounts, and then at potentially favorable rates: The employees can roll over their distributions in an IRA or other retirement plan or pay current tax on the distribution, with any gains accumulated over time taxed as capital gains. The income tax portion of the distributions, however, is subject to a 10% penalty if made before normal retirement age.

Note that all contribution limits are subject to certain limitations, although these rarely pose a problem for companies.

How does a ESOP work for a Start Up?

Startup’s perspective

A company cannot just grant options by issuing a simple letter to its employees. Often early-stage startups do this and then have to eventually handle disgruntled employees because they suddenly wish to exercise their options which, strictly under Indian law, were never really granted to them.

From a startup’s perspective, they have to do the following:

  • Get an ESOP scheme drafted and approve it in a shareholders’ meeting. Till June 2015, this scheme had to be approved by a ‘special resolution’ and filed with the Registrar of Companies (ROC). With effect from June 05, 2015, vide notification G.S.R. 464(E), private limited companies do not have to comply with Section 62(1)(b) of the Companies Act, 2013 which originally mandated ESOP schemes to be approved through a ‘special resolution’ and file its key terms with the ROC, making all this information available publically.
  • Once an ESOP scheme is approved, a Letter of Grant should be issued to the employee informing him how many options are being granted to him, what the vesting period would be and how the exercise price will be determined, should he choose to exercise the vested options.
  • In the event an employee wishes to exercise any of his vested options, he should make an Exercise Application to his employer company pursuant to which his options would be converted into equity.

What are the key points a startup should consider when getting its ESOP scheme drafted?

  • Most employees have employment contracts that allow termination upon giving some notice. How will a startup want to tackle a situation where some options have vested upon an employee but now he wishes to quit?
  • What happens if he is willing to work but the startup wants to terminate the employee’s employment for ‘cause’ or even otherwise by simply giving the notice period?
  • What if the employee has exercised some of his options and is a shareholder in the company but now wishes to resign or is asked to leave?
  • A startup would definitely not want an ex-employee to hold equity in its venture when such employee could very well be working for, say, a competitor. Accordingly, terms of an ESOP scheme have to be carefully thought out and discussed with the legal advisors.
  • ESOP schemes are audited and are referred to by auditors in their audit report. Accordingly, they cannot be back dated, especially when an audit report for the previous financial year has been prepared. Therefore, it is important to understand the legal regulations surrounding ESOPs before granting stock options to any employee.

Employee's Perspective

At the very outset, every employee should ask his/her employer for a copy of the ESOP scheme whenever he/she is granted stock options. This scheme will give a detailed insight into the terms and conditions associated with ESOPs. Once stock options are granted, there is a one-year cliff period. Any kind of vesting, i.e. the right to convert the stock options into equity, will only take place once the cliff period has lapsed. Thereafter, subject to the vesting schedule, i.e. how the vesting ought to take place, the employee will have a right to exercise his vested options by paying an exercise price to the employer. The exercise price is typically the face value of the shares. The entire exercise mechanism can be kept cashless as well, i.e. the vested options may be exercised and converted into equity without paying anything. All this information will be highlighted in the ESOP scheme and/or the Letter of Grant issued by the employer.

Let us explain the above with a simple example:

On September 01, 2015, a company grants its employee 100 options with a vesting period of two years and an exercise period of seven years at an exercise price of Rs 10 per share. Under the Company Rules, there is a one-year cliff period. This implies that the vesting will not commence till September 01, 2016. Since the vesting period is two years, half of the options (i.e. 50) will vest on September 01, 2016 and the remaining half on September 01, 2017. The exercise period of the vested options is seven years. This means that that the employee can convert his 50 options (that vested upon him on September 01, 2016) anytime before September 01, 2023. For the remaining 50 options that vested in 2017, the employee can exercise his right any time before September 01, 2024.

Let us now assume that on December 01, 2019, the employee decides to exercise his/her right to convert 70 options into common stock. At that stage, an Exercise Application will be addressed to the company. Assuming the exercise price was Rs 10 per share, the employee will pay Rs 700 (70 options * Rs 10 per share) to the company and the company will allot the employee 70 equity shares.

It is also pertinent to understand that in case an employee resigns, any unvested options (i.e. those that have not yet vested) will lapse. In case some options have already vested on the date of resignation, their treatment will be determined as per the terms of the ESOP scheme. Therefore, it is crucial that all employees who have been granted options read the terms of their company’s ESOP scheme very carefully.

In the end, I’d like to state that ESOPs are a great incentive for employees to put their heart and soul into an organisation. However, grant of options in itself does not mean that the employee will walk out of that organisation with millions in his bank account and employees should be conscious of this fact. Most young employees have only heard positive stories about ESOPs and often do not do their own diligence to understand the key terms governing their options. Some startups ask their legal advisors to make a presentation for their entire staff explaining how ESOPs work and how it can benefit them. This, in my view, is extremely beneficial. Failure to understand the intricacies is likely to leave you highly disappointed when you resign to move on to your next job.

Frequently Asked Questions

What is an employee stock ownership plan?

An employee stock ownership plan (ESOP) grants employees company shares, often based on the duration of their employment. Typically, it is part of a compensation package, where shares will vest over a period of time. ESOPs are designed so that employee motivations are aligned with company shareholders. From a company perspective, ESOPs have certain tax advantages, along with incentivizing employees to focus on company performance.

How does an employee stock ownership plan work?

First, an employee stock ownership plan is set up as a trust fund. Here, companies may place newly issued shares, borrow money to buy company shares, or fund the trust with cash to purchase company shares. Meanwhile, employees are granted the right to a growing number of shares, which rise over time depending on their employment term. These shares are sold at the time of retirement or termination, and the employee is remunerated the cash value of their shares.

What is an example of an employee stock ownership plan?

Consider an employee who has worked at a large tech firm for five years. Under the company’s employee stock ownership plan, they have the right to receive 20 shares after the first year, and 100 shares total after five years. When the employee retires, they will receive the share value in cash. Stock ownership plans may include stock options, restricted shares, and stock appreciation rights, among others. 

Comparative Analysis of ESOP, Sweat Equity and Phantom Stocks


With the growing job opportunities and the increase in competition, companies have to ensure that there is a minimization of attenuation and attrition of employees. For the purpose of ensuring the same, the companies offer incentives to their employees in the form of stock options and shares to ensure that the employees are well-motivated and retained by the company for a longer time period. The most popular form of incentive provided to the employees is employee stock options. However, few other forms of incentives are also available to the employees such as the offering of sweat equity shares and phantom stocks.

In this article, we will be discussing in detail the comparative analysis of employee stock options, sweat equity shares and phantom stocks.


An employee stock option is one form of incentive which is provided to an identified group of employees. The main purpose is to motivate the employees through ownership in the company by way of issuing equity shares to them. The directors, employees or officers are given the right to purchase or subscribe to the shares of the company at a price which is pre-determined and at a future date as mentioned in the grant letter. The options are granted to the employees in accordance with the employee stock option scheme and upon the completion of a minimum period of 1 year from the date of grant of options, the employee shall have the right to exercise the options. The date on which the employee becomes entitled to exercise the right to acquire the shares of the company shall be referred to as vesting date. The terms and conditions with regard to the grant and the exercise of options shall be clearly laid down in the employee stock option scheme and in the grant letter which the company shall provide to the employee. Upon the exercise of the options by the employee after the completion of the specific timelines, the company shall issue shares to the employee.


Sweat Equity shares are shares issued by the company to the directors or the employees of the company at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions. In accordance with Rule 8 of the Companies (Share Capital and Debenture) Rules, 2014, value addition shall mean actual or anticipated economic benefits derived or to be derived by the company from an expert or a professional for providing knowhow or making available rights in the nature of intellectual property rights, by such person to whom sweat equity is being issued for which the consideration is not paid or included in the normal remuneration payable under the contract of employment, in the case of an employee.


A Phantom Stock Option is one form of stock option plan wherein the underlying value of the shares of the company is provided to the non-employee/employee i.e. the non-employee/employee is provided with a cash entitlement upon the occurrence of certain events and completion of certain timelines. This is a performance-based incentive which is provided to the non-employee/employees for the purpose of effective performance and the retention of the non-employee/employees in the organization. The cash entitlement which becomes payable to the non-employee/employees is linked to the share value. In the event, there is a hike in the price of the shares there is a likelihood for the non-employee/employee to get a higher cash entitlement. There is no dilution of the share capital in phantom stocks as shares are not issued to the non-employee/employees, as the underlying value of the share is provided, which is payable in the form of cash.

There are two kinds of phantom stocks i.e. full value and appreciation only. A full value phantom stock shall entitle the non-employee/employee to receive the value at which the stock is worth at the time of the cash settlement. In the appreciation only method, the non-employee/employee would not be provided with the cash settlement at the current value of the stock but at a value i.e. the difference between the value at which the stock was granted to the non-employee/employee and the current value of the stock. For the purpose of issuance of phantom stock, an agreement shall be entered into between the non-employee/employee and the company. The phantom stocks are granted to the non-employee/employees as per the terms and conditions as laid down in the agreement. The number of units along with the specific timeline is detailed out in the agreement. The starting value of the unit shall be mentioned in the agreement and similar to the non-employee/employee stock options, the vesting schedule, the events of payment such as liquidation event such as infusion of funds, merger, acquisition, change in control, strategic investment in the company etc. or any other mechanism shall be clearly laid down in the agreement.

There is no law which governs the issuance of phantom stocks and the same are usually governed by the agreement entered into between the non-employee/employees and the company. The Companies Act, 2013 does not have any provisions which would govern the phantom stocks.


Parameters:Employee Stock Options:Sweat Equity Shares:Phantom Stocks:
1.Meaning:Section 2 (37) of the Companies Act, 2013:


“Employee stock option means the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.”

Section 2 (88) of the Companies Act, 2013:


“Sweat equity shares means such equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.”

A stock option plan in which the underlying value of the share is provided to the employee/non-employee in the form of a cash entitlement in accordance with the terms laid down in the agreement entered into between the company and the employee/non-employee.
2Governed by:Section 62 (1) (b) of Companies Act, 2013 read with Rule 12 of


Companies (Share Capital and Debenture) Rules,  2014.

The listed entities have to comply with Securities and Exchange Board of India Regulations on Employee Stock Options.

Section 54 of Companies Act, 2013 read with Rule 8 of


Companies (Share Capital and Debenture) Rules,  2014.

The listed entities have to comply with Securities and Exchange Board of India Regulations on sweat equity.

Agreement entered into between the employees/non-employee and the company.
3Issued to whom:a)  A permanent employee of the company who has been working in India or outside India.



b)  Director of the company, whether whole-time director or not, excluding an independent director.

c)  An employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company but does not include- (i) an employee who is a promoter or a person belonging to the promoter group; or (ii) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten per cent of the outstanding equity shares of the company.

Start-ups may issue the employee stock options to its promoters and directors who hold more than 10% for a period of 10 years from the date of their incorporation.

a)  A permanent employee of the company who has been working in India or outside India or


b)  A director of the company, whether a whole-time director or not; or

c)  An employee or a director as defined in sub-clause (a) or (b) above of a subsidiary, in India or outside India, or of a holding company of the company.


Non-employees such as promoters, agents, consultants, advisors etc and employees.
4Share Capital Dilution:The share capital is diluted if the options issued to the employees are vested.The share capital is diluted as the shares are issued to the employees.The share capital is not diluted as the underlying value of the shares is given to the employee/non-employee.
5Consideration:Employees are required to pay the predetermined price of the shares at the time of exercise in cash. The consideration can be in cash, IPR or non-cash.Employees/non-employees are not required to pay any price. In turn, the company is required to pay the employee the underlying value of the shares as a cash payment to the employees/non-employees.
6Valuation:The Company has the freedom to determine the exercise price in conformity with applicable accounting policies. The issue price shall not be less than the intrinsic value of the shares.The sweat equity shares to be issued at a value determined by a registered valuer as the fair price. Valuation of intellectual property rights or of know-how or of value additions or of any non-cash consideration shall be determined by a registered valuer. The shares may be issued at a discounted price or free for know-how.The valuation of stock would be done as per the terms and conditions of the agreement.
7Resolution:Employee Stock Option Scheme shall be approved by the shareholders of the company by passing a special resolution.


For private companies, the Employee Stock Option Scheme shall be approved by the members through the passing of an ordinary resolution. Approval of shareholders by way of separate resolution shall be passed for the grant of an option to employees of the subsidiary or holding company or for the grant of options to identified employees during one year equal to exceeding one per cent of the issued capital of the company at the time of grant of the option which shall exclude outstanding warrants and conversions.

For the purpose of issuance of the sweat equity shares, a special resolution shall be passed by the company in a general meeting.


The special resolution authorizing the issue of sweat equity shares shall be valid for making the allotment within a period of not more than twelve months from the date of passing of the special resolution.

No resolution is required to be passed. These are issued in accordance with the terms laid down in the agreement.
8Lock-in and Vesting Period:The minimum vesting period shall be one year from the date of granting of the options after which the options can be exercised by the employees.


The company shall have the freedom to specify the lock-in period for the shares issued.

The sweat equity shares shall be locked-in for a period of 3 years from the date of allotment.As per the timelines laid down in the agreement.
9Dividend and Voting Rights:Upon the exercise of the option and issue of shares to the employees, the employee shall have the right to receive dividends and shall have the voting rights in the company.The employees shall have the right to vote and receive dividends from the company.The dividend is not payable and there are no voting rights as there is no issuance of shares.
10Transferability:The options are neither transferable nor can they be hypothecated, pledged, mortgaged or encumbered or alienated in any manner.The sweat equity shares shall not be transferable for a period of 3 years from the date of allotment.It shall be in accordance with the agreement. However, in our practical experience, these cannot be transferred.
10Maintenance of Registers:The company shall maintain a Register in Form SH-6.The company shall maintain a Register in Form SH-3.There is no requirement for maintenance of any register for the issue of these stocks.
11Restriction on the limit of increasing paid-up share capital:The company can raise any amount of paid-up share capital by issuance of ESOP’s.Only up to 15% of the existing paid-up equity share capital shall be issued in the form of sweat equity shares in year or shares of the issue value of Rs. 5 crores, whichever is higher, provided that the issuance of the sweat equity shares of the company shall not exceed 25% of the paid-up equity share capital of the company.


A startup may issue sweat equity shares not exceeding 50% of the paid-up capital up to 5 years from the date of its incorporation or registration.

They are issued to any manager or director of the company.

There is no increase in paid-up share capital of the company as no shares are issued.
12Disclosure in Directors Report:The Board of Directors shall disclose details of Employee Stock Options Scheme in the Directors Report.The Board of Directors shall disclose details of the issue of shares in the Directors Report for the year in which the shares are issued.There is no requirement to disclose the issue of stock in the Board Report.