ESOPs allow private limited companies to attract high-caliber talent by offering equity instead of high cash compensation. Setting up a scheme involves low regulatory friction requiring just one board meeting, a shareholder resolution, and a single ROC filing (Form MGT-14). Under Indian corporate laws, a mandatory one-year cliff (vesting period) applies before employees can exercise options.
Introduction
The hire you cannot afford in cash is often affordable in equity. That is the whole case for ESOPs, and the law keeps the entry cost low: a private limited company needs one board meeting, one shareholders' resolution, and one ROC form to put a scheme in place, and the minimum vesting period is just one year.
This guide sets out the exact procedure under Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014, the way a company secretary would run it in 2026.
What is an ESOP under the Companies Act, 2013?
An ESOP is a right, not an obligation: the company gives its directors, officers, or employees the option to buy or subscribe to its shares at a future date, at a price fixed today. Section 2(37) of the Companies Act, 2013 defines the term, and it stretches to cover employees of the company's holding and subsidiary companies too.
Until an option is exercised and shares are allotted, the employee is not a shareholder no votes, no dividends, only a promise that grows valuable as the company does.
Who is eligible for ESOPs, and who is excluded?
Permanent employees and most directors qualify; promoters, independent directors, and directors holding over 10% of equity do not unless the company is a recognised startup.
| Eligible under Rule 12 | Excluded under Rule 12 |
| Permanent employees working in India or abroad | Independent directors |
| Directors, whether whole-time or not | Promoters and members of the promoter group |
| Employees and directors of a holding or subsidiary company | Directors holding more than 10% of equity directly, through relatives, or through a body corporate |
| -- | Consultants, advisors and anyone not on the payroll |
What approvals does a private company need to issue ESOPs?
A board resolution adopting the scheme, followed by shareholder approval at a general meeting. For private companies, an ordinary resolution is enough the MCA's exemption notification dated 5 June 2015 replaced the special resolution requirement of Section 62(1)(b).
One caveat: Rule 12's text was never amended to match, so many secretarial teams still pass a special resolution and file Form MGT-14 within 30 days as belt-and-braces. Pick a route deliberately, not by accident.
The explanatory statement to the notice must disclose the scheme's core mechanics: total options; classes of employees covered; the appraisal process; vesting requirements and the maximum vesting period; exercise price or formula; exercise period and process; lock-in, if any; and the valuation method for the options.
Two situations need a separate shareholders' resolution under Rule 12(4): options granted to employees of a holding or subsidiary company and grants to any identified employee equal to or exceeding 1% of issued capital in a year.
What is the step-by-step procedure to issue ESOPs?
Eleven steps take a private company from a draft scheme to allotted shares, and a well-run approval stage closes within four to six weeks.
- Step 1: Draft the ESOP scheme in line with Rule 12.
- Step 2: Send notice of the board meeting to all directors. ( At least 7 days before )
- Step 3: Hold the board meeting: approve the scheme, pool, and pricing; call the general meeting.
- Step 4: Send the general meeting notice to members, directors, and auditors. ( 21 clear days [shorter with 95% consent] )
- Step 5: Pass the shareholders' resolution, plus separate resolutions where Rule 12(4) applies.
- Step 6: Issue grant letters to selected employees.
- Step 7: Record every grant in the Register of Employee Stock Options.
- Step 8: Let vesting run ( Minimum 1 year from grant )
- Step 9: Receive exercise letters and the exercise price. ( Within the scheme's exercise window )
- Step 10: Hold a board meeting to allot the shares
- Step 11: File the return of allotment with the ROC. ( Form PAS-3, within 30 days )
What rules govern vesting, exercise price, and lock-in?
Vesting must run at least one year, the exercise price cannot fall below face value, and lock-in after exercise is entirely the company's call.
- The one-year floor counts from the grant date. Where new options replace those held in a company that merged into yours, the earlier holding period is adjusted against the minimum.
- The company sets the exercise price freely, and it can differ from employee to employee through grant letters but never below face value, since discounted issues are barred by Section 53.
- Option holders earn no dividends and cast no votes until shares are actually allotted.
- The scheme must spell out lapse and forfeiture typically, unvested options return to the pool when an employee exits.
| You will need a defensible fair value twice: for the books at grant and a merchant banker valuation of FMV at exercise to compute perquisite TDS. TaxLegit's valuation team handles both. |
What compliance continues after allotment?
From maintaining the SH-6 register to accurately managing multi-stage TDS calculations under the Income-tax Act, it doesn't have to burden your team or leave room for costly penalties.
That’s where Taxlegit comes in. By partnering with us, you can offload the heavy lifting of post-allotment compliance to dedicated experts. We ensure every board disclosure is timely, every tax withholding is precisely calculated (including startup deferrals), and your registers remain audit-ready at all times.
Instead of second-guessing complex regulatory updates or risking missed deadlines, you can focus on growing your business while we handle the fine print. Let Taxlegit safeguard your ESOP management reach out to our team today to get started.
Set Up Your ESOP Scheme the Right Way
From drafting the scheme to filing Form MGT-14 and PAS-3, TaxLegit handles the resolutions, valuations, and post-allotment compliance so your ESOP pool holds up in your next funding round instead of becoming a diligence flag.
Frequently Asked Questions
1Can consultants or advisors receive ESOPs?
No, Rule 12 limits options to payroll employees and directors; advisor equity needs a different route, such as a direct share issue.
2Can an employee who already holds shares get options?
Yes, as long as they are not a promoter and, if a director, do not cross the 10% holding test.
3Can the exercise price differ between employees?
Yes, Grant letters can set different prices for different people, but never below the face value of the share.
4What happens to options when an employee resigns?
Whatever the scheme says. The usual design: unvested options lapse back to the pool, and vested options must be exercised within a defined window.
5Can the company help employees fund the exercise?
Yes, The scheme can build in a company loan or a cashless mechanism, and the exercise window can be extended with the required approvals.
6Is fresh shareholder approval needed for every grant?
No, One approval covers grants within the sanctioned pool. Go back to shareholders only to expand the pool, vary scheme terms, or for the Rule 12(4) cases above.
About the Author
Srijita
Content Writer
Srijita is a legal and financial content specialist with 5+ years of experience in the Indian corporate sector. She simplifies MCA regulations and tax compliance into clear, actionable insights for entrepreneurs, working closely with Chartered Accountants and legal experts to ensure accuracy and compliance. Reviewed by Vipul Sharma, Co-Founder, Taxlegit.
