Introduction of ESOPs in India
ESOP stands for Employee Stock Ownership Plan (ESOPs in India), which is an employee benefit plan that gives employees an ownership interest in the company. The Employee Stock Ownership Plan (ESOP) operates through stock options that allow employees to buy company shares after a certain period at a fixed price. This framework allows employees to share in the company’s growth and financial success.
Purpose of ESOPs in India
Initially, ESOPs were introduced in India post-liberalization in the early 1990s to attract and retain talent for industries like start-ups and high-growth companies. Having a stake in the company’s future profits aligns employee interests with the future success of the business; employees see their respective roles and tasks as contributing to the long-term success of the company, creating loyalty and motivation to do the best job possible.
Moreover, there are several queries for the phrase “ESPO in India,” which is a typo/misinterpretation of the term ESOPs itself. This guide answers everything you need to know about ESOPs, including their benefits, tax implications, and how companies can implement them most effectively.
What Are ESOPs in India? Legal Definition & Working
ESOPs in India (Employee Stock Ownership Plans) are a type of employee benefit plan that is designed to provide employees with an ownership interest in the company. ESOP stands for Employee Stock Option Plan which is similar to stock options, but in this case, employees are given the option to buy a share of the company at a predetermined price after a certain period. This will ensure that even the employees of the company can take advantage of the growth and profit of the firm.
However, ESOPs in India were initially introduced as a mechanism to attract and retain talent, particularly in startups and high-growth sectors. It would give employees a stake in the company a great way to instill loyalty and motivate employees to help guide the company toward long-run success by having their share in future profits.
Key Legal Elements of ESOPs in India
- Grant: The grant is a company’s first offer to eligible employees indicating how many options the employee can purchase and how much they can pay for the shares down the line.
- Vesting: Vesting means the duration during which employees can exercise their stock options. Vesting is either on a time or performance basis. For instance, a company might stipulate that 25% of the options will vest every year over four years.
- Exercise: After the options vest, employees have the right to exercise the options to buy the shares at the set price (exercise price).
- Selling: Once the options are exercised and the shares are obtained, employees can sell those shares in the market (if the company is listed) or with the company (in case of an unlisted company) and make a profit.
Recognizing these stages allows employees to maximize their financial outcomes by deciding when to exercise their options.
Common Industries Offering ESOPs in India
- Tech Industry: ESOPs are common among IT and Software companies, where the hiring of competent professionals is pivotal.
- Startups: Startups typically resort to ESOPs as a big guiding factor while hiring talent when the cash compensation is low.
- Pharma & Biotech: ESOPs are used here to reward innovations and retain top scientists and researchers.
- Financial Services: Employee stock ownership plans are popular in the fintech and banking sectors, where the quality of employee performance directly affects the growth of the entire business.
Are ESOPs Allowed under the Companies Act, 2013 in India?
Yes, ESOPs in India are permissible under the Companies Act, of 2013, which lays down a robust legal framework for the issuance of ESOPs. The Act lays down rules and regulations for companies (listed and unlisted).
The Companies Act: Key Provisions Governing ESOP in India
1. Eligibility: ESOPs may be issued to:
- The company’s permanent employees.
- The directors of the company, other than independent directors.
- Officer and consultants, subject to board approval.
However, ESOPs cannot be issued to promoters or directors holding more than 10% of the company’s equity, unless approved through a special resolution by shareholders.
2. Approval Process:
- ESOP issuance must be approved by the board of directors.
- The ESOP scheme also needs to be passed (through a special resolution, in the general meeting) by the shareholders.
3. Disclosures:
- Companies are required to disclose certain details on the ESOP scheme in their financial statements which should include several options granted, vested, and exercised during the year.
4. Lock-in Period:
- There may be a minimum lock-in period during which employees cannot sell shares acquired through ESOPs. Such provisions allow for transparency and safeguard the interests of both employees and shareholders.
Benefits of ESOPs in India for Employers and Employees (2025 Update)
ESOPs have various merits for both the employer and the employee, thus they provide a significant instrument in talent management in providing investment and financial planning tools.
Benefits for Employers
- Talent Acquisition: Candidate engagement and thus ESOP offerings are keys to attracting quality talent.
- Employer Retention: The vesting period forces employees to remain with the firm for a longer period, minimizing turnover.
- Source Of Motivation: ESOPs provide incentives for employees to contribute to the success of the organization, as they directly benefit from the company’s growth.
- Low-Cost Employment: Companies may avoid giving high salaries instead they may provide ESOPs that help employers to attract talent while managing immediate payroll expenses.
Benefits for Employees
- Wealth Creation: ESOPs allow employees to create wealth as the company grows in valuation.
- Sense of Ownership: It makes employees more attached to the company and take ownership of their work.
- Tax Benefits: Employees may end up paying lower capital gains tax rates (if shares are sold) by planning correctly.
Example of Wealth Creation with ESOPs in India
Imagine, an employee is allotted 1,000 ESOPs with an exercise price of ₹50 per share. On the completion of four years (when the options vest), the market price of the shares is ₹200. Upon exercising the options, the employee selling out ₹50,000 (1,000 shares x ₹50) gets ₹200,000 worth of shares. After selling the shares, the employee makes a profit of ₹ 150,000, which is taxed as per the applicable rates.
Types of ESOPs in India (Traditional, RSUs, SARs, and More)
Indian companies have seven types of stock-based compensation plans depending on the purpose of the particular compensation arrangement.
1. Traditional ESOPs in India
This means employees can buy the shares at a fixed price. The main advantage is being able to buy shares at a discounted price, relative to current market value.
2. Phantom Stocks in India
Phantom stocks do not issue real stocks. Employees are instead rewarded with cash bonuses equal to the value of a certain number of shares. This approach prevents equity dilution, while fairly providing compensation.
3. Stock Appreciation Rights (SARs) in India
SARs give employees the right to take in the appreciation of stock prices over a defined time frame. Similar to phantom stocks, SARs are a cash-settled financial product, making it a non-dilutive alternative to the conventional ESOP.
4. Restricted Stock Units (RSUs) in India
RSUs are literal shares given to an organization member that is limited by a vesting period and also performance metrics. The employee becomes a shareholder with full rights once the shares are vested.
ESOP Example in India
Here is an example of an Employee with ESOP in India.
| Stage | Description | Details |
| Grant | A company grants stock options to its employees | 10,000 stock options at ₹100/share. |
| Vesting | Options vest over 4 years | 25% after each year |
| Exercise | The employee sells the shares at ₹300 each | Paying ₹10,00,000 (10,000 shares x ₹100) |
| Sale | Employee sells the shares at ₹300 each | Earns ₹30,00,000, taxed as capital gains |
In the example above, the employee exercises and sells his/her ESOPs and makes a sizeable profit. Learn more by visiting Corrida Legal’s article on How to be compliant with Data Protection & Privacy Laws in India.
How to Issue ESOPs in Indian Company
How to Implement ESOPs in Indian Companies (Step-by-Step)
However, issuing ESOPs in India requires a sequence of steps that companies need to follow dutifully to ensure compliance and effectiveness.
Process of Issue of ESOPs in India
- ESOPs Plan Structuring: Lay out the goals, eligibility, and important terms such as vesting period, exercise price, lock-in period, etc.
- Setting up an ESOPs Pool: Set aside a certain percentage of the company’s total equity for ESOPs.
- Drafting Format of the ESOPs Scheme: With the terms and conditions of the ESOP framed out, the next step is to put them in the new document format.
- Approval: Obtain approval from the board of directors and shareholders by a special resolution.
- ESOPs grant of option: Inform eligible employees of ESOP options defining grant date, vesting, and exercise price
- Maintain Compliance and Reporting: Keep records of stock options granted and comply with reporting under the Companies Act, 2013.
Legal and Regulatory Framework for ESOPs in India
The key regulations about ESOPs in India are as follows:
SEBI Regulations for ESOPs in India
- SEBI (Share Based Employee Benefits) Regulations, 2014: These regulations apply to listed companies and require disclosure, reporting, and governance standards for the ESOPs.
ESOP Guidelines under the Companies Act, 2013
- Companies Act, 2013: Regulates the issuance of ESOPs for unlisted companies, outlining eligibility, approval, and compliance requirements.
- Income Tax Act, 1961: It lays down the tax treatment for ESOPs when they are exercised and sold.
The Process Simplified — ESOPs in India
The four key stages of the ESOP process are:
- Granting: The Company shall grant stock options to eligible employees.
- Vesting: Employees will earn the right to exercise their options over time by a vesting schedule.
- Exercise: Employees purchase shares at the exercise price.
- Exiting: Shareholders, including employees, may sell their shares after the lock-in period expires, as a means of realizing their financial gains.
Tax Implications of ESOPs in India (2025 Guide)
The taxation treatment of ESOPs in India can be complicated and entails multiple taxation stages:
- At the time of Exercise: The difference between the fair market value (FMV) of the shares and the exercise price is treated as a perquisite and taxed under “Income from Salary.”
- At Sale: You pay capital gains tax on the difference between the sale price and FMV when the option is exercised.
Capital Gain on Tax Rate in India
- Listed Shares: 15% on short-term capital gains, if sold within 12 months and 10% on long-term capital gains beyond ₹1 lakh.
- Unlisted Shares: Long-term capital gains of 20% + indexation benefit on unlisted shares held for over 24 months.
Key Steps for Companies to Implement an ESOP Plan in India
- Develop a sound ESOP plan that fits the company’s goals.
- Include all legal and regulatory compliance.
- Provide effective ESOP communication to employees
- Periodic review and update of the ESOPs scheme.
Common Challenges in ESOP Implementation in India
- Valuation Issues: Arriving at the fair market value of shares in unlisted companies can be a challenge.
- Issues With Liquidity: Employees may have difficulty selling shares too, especially if the company is not listed.
- Regulatory Hurdles: You have to comply with regulatory requirements.
ESOPs Buyback and Exit Strategies in India
In India, companies either buy ESOP back or offer go-to employees to provide liquidity. Some of the employee exit strategies can be:
- Initial Public Offering (IPO): Offloading shares at the company’s initial public offering.
- Buyback: The company buys back shares from employees at fair value.
- Acquisition: If the company is acquired, employees can sell shares.
FAQ
Q1. Are ESOPs in India available for all employees?
No, ESOPs are meant to be issued to permanent employees, directors, and officers.
Q2. Are ESOPs taxable at the time they are granted?
No, taxation happens at the exercise and sale stages.
Q3. What happens to ESOPs when the employee leaves the company?
Unvested options get forfeited, and vested options can usually be exercised for a defined period.
Q4. Can ESOPs be transferred to another person?
ESOPs cannot be transferred other than because of the employee’s death or disability.
Conclusion
They are a new way to reward and retain talent across the country with a healthy sense of ownership of the company they work with. They provide immense financially oriented incentives for employees and are a means for companies to scale by having employees adopt the mindset of the organization vis-a-vis the Equities. Understanding the nuances of ESOPs is crucial to those considering one as a plan sponsor or as a stakeholder in such a plan.
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