Last Updated on March 18, 2026
In the era of layoffs and retrenchment, certain companies wish to secure their employees’ talent and retain them in the company through various schemes- one such scheme is ESOP- Employee Stock Ownership Plan. This Scheme allows employees to purchase shares in the company where they work at a predetermined price, creating a sense of ownership and loyalty among employees.
ESOP (Employee Stock Ownership Plan) is a popular employee benefit scheme that allows employees to own shares in the company they work for. In this article, we explain what ESOP is, how it works in India, its benefits, risks, and the complete process step by step.
ESOP- Employee Stock Option Plan – Meaning
As the name suggests, ESOP is a scheme where the employees who have been associated with the company for a while are given the option to purchase stock/shares of the company at a pre-determined price upon fulfilment of certain conditions/criteria. It is the reward for the risk taken and efforts put in by the employees to foster the growth and development of the company.
What Are The Key Benefits Of ESOP?
This scheme offers multiple benefits to the employees, a few of which are given below:
- The employees are allowed to become owners of the company because shareholders own the company, and by purchasing the stocks of the company, they can own the company.
- The employees are given the benefit of purchasing the shares at the lesser share value price than offered to the public at large
- It provides the employees with long-term investment plans, and the employees will benefit from the scheme as the company grows.
- It adds value to the wealth of the employees, as it is a bonus or addition to the fixed salary earned by the employee
- It improves employee retention in the business.
What Are The Risks Associated With ESOP?
With every reward comes risk, and so does this scheme. Lets us see what the risks associated with the ESOP scheme are:
Imagine a situation where a startup company grants an ESOP option to its employees. With God’s grace and the efforts of the employees, the startup is doing well and growing, and so are the share prices. But there arises a situation were company is unable to release the IPO, leading to employees being unable to cash out. This situation demands that the employees stay loyal and patient. Some do, some cannot, and that is when ESOP becomes a risky affair. Here is a list of risks and challenges associated with the ESOP scheme
- With the rise and fall in stock prices, the options may lose value and become volatile
- The employees have to put in their own money to buy shares
- The employees will have to adhere to the taxation schemes applicable to the scheme
- There are high chances of dilution of ownership, which can lead to discontentment and impact company morale
- It increases administrative burden and can increase legal issues
Eligibility Criteria For ESOP
The eligibility criteria differ from company to company and are usually based on the time requirement. The criteria must be clearly defined in the plan to avoid confusion.
- Permanent employees of the company
- Directors
- Key managerial personnel at the top and middle-level management
Note: Independent directors are not eligible under this scheme. Also, individuals who already hold more than 10% of the equity shares of the company are not eligible.
How Does ESOP Work in India? (Step-by-Step Process)
1. The company provides a detailed scheme to the employees
This scheme covers the following details :
- Eligibility
- Number of options
- Exercise price
- Vesting schedule
- Conditions of sale
2. Determination of vesting period
This is the period during which the employees earn the right to exercise their options. In India, it is usually one year, but it may differ from company to company. It is important that the employees are in continued employment during the vesting period.
- The next stage is for the employees to exercise their options and pay the price of the shares to acquire the stocks
- In the last stage, once the stocks are exercised, employees can either hold them or sell them, subject to company policies.
What is the Vesting Period under ESOP?
Simply speaking, the vesting period is the period during which an employee has to be part of the company; only then will the employee have the right to ownership over the shares. There are various types of vesting period:
- Cliff-based vesting – employees do not have a vesting period until they fulfil the minimum continuous service period.
- Graded vesting- this usually comes after the cliff period is over.
Typically, India follows a 3–5-year vesting period, but the cliff period is also for one year. It depends on the company.
Laws Regulating The ESOP Scheme
- For listed companies- SEBI regulations, 2021
- For unlisted companies- Companies Act, 2013
- For taxation rules- the Income Tax Act, 1961
ESOP Buyback and Exit Regulations
When an employee resigns or retires from the company, they have the option to buy back the vested shares at the fair market value, as per the process laid down in the Companies Act, 2013.
ESOP Compliance Checklist
When structuring an ESOP for the company, it is required that the company’s policy be drafted clearly to avoid repercussions. Here is what you need to do:
- Preparation of a detailed ESOP scheme that will serve as a foundation for obtaining approval and implementation.
- Once the draft is ready, it is required to obtain approval from the board members.
- Organise a general body meeting to secure shareholder approval through a special resolution
- File Form MGT-14 with the ROC within 30 days of passing the resolution
- Maintain a register in Form SH-6 to record all ESOP grants, vesting details, and related legal and audit compliances.
- Issue grant letters to all eligible employees
- Allot shares to employees after the payment of the share price value
How Can Kanakkupillai Help?
From assisting you in drafting the ESOP scheme to helping you comply with the compliances in the Companies Act and guiding you through the taxation system, we offer a wide range of services. Contact us to know more.
Key Takeaways
To sum up,
ESOPs are a powerful tool for creating wealth and management that helps employers retain employees in the company. It fosters a sense of loyalty and trustworthiness among employees. It involves a lot of legal compliance, which can be complex and require expert help.
Frequently Asked Questions
1. Can private companies issue ESOPs?
Yes, both public and private companies can issue ESOPs.
2. What is the vesting period?
3-5 years, but with an option of a one-year cliff period.
3. Is there any financial risk associated with ESOP?
Yes. Contact us to know the ways to mitigate the risk.
4. How is ESOP taxed in India?
ESOPs in India are subject to dual tax. First, when they buy shares, and second, when they sell shares after exercising their options.
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