Coupon Accepted Successfully!


Employee Stock Option Plans (ESOPs)

An ESOP is an option given to whole-time directors, officers or employees of a company (note that partnerships, LLPs or sole proprietorship businesses can not issue ESOPs though they may be able to devise some other incentive scheme), which gives such directors, officers or employees (as applicable) the right to purchase or subscribe to the securities offered by the company at a predetermined price on a future date (See Section 2(15A) of the Companies Act; SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 (SEBI Guidelines). Stock options have been a very common method used by companies, especially in the technology sector, to incentivise employee performance and to reward them.


In 2001, 1,22,200 Infosys shares issued pursuant to an ESOP scheme started in 1994 became freely tradable, worth Rs 47.75 crore for 1,525 eligible employees. In 2010, Infosys and WIPRO both re-introduced ESOP schemes to reduce employee attrition rates.



i.    What are the advantages of an ESOP to an employee and an entrepreneur?

An ESOP is essentially devised by an organization to provide incentives to employees to perform better. The realization of the benefits of the ESOP is usually structured in such a way that an employee is required to stay for a certain period of time before he is able to reap the benefit. For an employee, the ESOP acts as a reward for the effort he has put in over a long period of time. It also creates a direct financial interest of the employee in the success of the company. If the company performs better, his ESOPs will be valued higher. Since the employee often works at a lesser salary compared to market rates, this leads to sharing of the business risk by the employees, and they are handsomely rewarded for the risk that they take if the business does well in the long run.

When an employee exercises an option to buy shares under a ESOP scheme, he is required to pay a pre-determined price for the shares to the company. An employee makes a profit only if the market value of the shares is higher than the price paid by the employee to purchase the share. Therefore, if the company has not performed well and the market price of the shares is lower than the price they have to pay to purchase the share, ESOPs will not be of any value to the employee, and they would not exercise the option to buy shares of the company under the ESOP scheme in that case.

Transferring shares purchased by exercising ESOPs is easy for employees in the case of a listed public company, because the shares are listed on the stock exchange. This implies that there is usually a market for the shares, that is, there are willing buyers for the shares, and the market price of the shares is easily discoverable. The employees benefit the most from ESOP scheme when a company goes public. You may have read about the bonanza reaped by Facebook employees when Facebook listed its shares through and IPO. Sometimes shares obtained under ESOPs may pay off in an unlisted company also if an investor/ share-holder is willing to buy them from the employees to increase his shareholding in the company.

Legal framework governing ESOPs

Rules and regulations related to grant of stock options in listed companies are governed by the SEBI (Share Based Employees Benefits) Regulations, 2014 from 28th October, 2014. Earlier, the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 (SEBI Guidelines) used to govern grant of stock options in listed companies. All listed companies who had existing ESOP schemes, should comply with the new regulation within one year from the date of notification of the 2014 regulations. Earlier, there were no specific rules to govern ESOPs by private companies and unlisted public companies. However, after the Companies Act 2014, issuance of employees stock options by private and unlisted public companies is now governed by the Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 (which are very similar to the SEBI Guidelines).

Earlier, an unlisted company will be required to comply with the SEBI Guidelines only at the time of listing. Therefore, if at the time a company goes for an IPO, its ESOP plan and the terms of outstanding options (i.e. options which have not been exercised by employees) must be modified to be compliant with SEBI guidelines.

Earlier, in order to prevent such adjustments at the time of IPO, private companies and unlisted public companies tend to model their ESOP plans in a manner similar to the SEBI Guidelines or alternately, ensured that all the options that were granted through the lifetime of the company were exercised or lapsed before the IPO.

The mechanism of issuing shares is similar in the event of both private and public companies. However, any thresholds or limits that are specified are taken from the SEBI Guidelines.

Issuance of ESOPs by an unlisted company

ESOPs can be granted to the permanent employees of the company, a director of the company (including a whole time director, but not an independent director) and includes permanent employees and directors working outside India and those working in a subsidiary, holding and associate company. However, ESOPs cannot be granted to:

  1. an independent director
  2. a promoter who is an employee, or
  3. employee who belongs to the promoter group or
  4. a director who (either by himself or through his relative or a corporate body) directly or indirectly holds more than 10% of the shares of the company.
Professionally appointed CEOs who do not belong to the promoter group and have less than 10 percent shares in the company can therefore be granted ESOPs. 

What are the procedural requirements that must be followed during issuance of ESOPs by an unlisted company?
i) The ESOP scheme must be approved bv the shareholders of the company by a special  resolution (resolution ordinary  in case of a private company).

ii) Companies have the freedom to determine the “exercise price” (which should be in conformity with the accounting principles and standards)

iii) If a company wants to grant ESOPs to the employees of the subsidiary, holding company or wants to grant ESOPs which would be more than 1% of the issued share capital of the company, it must take approval of the shareholders through a separate resolution.(ordinary resolution in case of a private company).

iv) The terms and conditions of the ESOP scheme which has not been exercised by the employees can be varied (but which won’t affect the rights of the employees in a negative manner) by passing a special resolution.

v) There must be a minimum gap of one year between the grant of option and vesting of option.

vi) Companies can specify a lock-in period on the shares issued under ESOP scheme

vii) Non-transferability of the ESOPs (except to the legal heirs or nominees in case of death of the employee)

viii) The Board of Directors must disclose information related to ESOPs issued to the employees in the Director’s Report.

ix) Maintenance of a register of ESOP as per Form No. SH.6
Issuance of ESOPs by listed companies

ESOPs are usually issued to employees of the company, they may even be granted to directors (unless they hold more than 10% of the shares of the company).
ESOPs cannot be issued to:
  1. a promoter who is an employee, or
  2. employee who belongs to the promoter group or
  3. a director who (either by himself or through his relative or a corporate body) directly or indirectly holds more than 10% of the shares of the company.

 Ways of structuring an ESOP

An ESOP may either be directly granted by the company to the participating employees, or it may be administered by an independent irrevocable trust. If the scheme would be administered by a trust, the company must take the approval of the shareholders at the time of establishing the scheme.
Trust: In case a company adopts the trust route, the shares are held by the trust for the benefit of the employees until the options are exercised by the employees. The trust may subscribe to shares issued by the company, or purchase shares from the existing shareholders. However, trusts are not allowed to acquire more than two percent of the total paid up capital of the company through secondary acquisition, ie., purchase from the listing platform, in one financial year. Additionally, trusts can purchase a maximum of 5 % of the total paid up share capital through secondary acquisition. The finance for the shares is usually obtained by a financial institution or the company itself, or a combination of both. The money is repaid once the employee exercises the option and purchases the share from the trust. 

Discussion on legal validity of the trust route As per Section 77 of the Companies Act, 1956/ Section 67 of the Companies Act, 2013, no public company, and no private company which is a subsidiary of a public company, can provide financial assistance (whether by way of loan, guarantee or in any other way) for the purchase of its own shares or shares of its holding company.

However, this section does not apply to i) a private company (unless it is a subsidiary of a public company) and ii) purchase of shares if they are held for the benefit of its employees.
Hence, a private company or a public company can provide financial assistance for purchase of its own shares by a trust under an ESOP.

A. How an ESOP scheme works

How does an ESOP work

The life of an ESOP is divided into three stages – grant of options, vesting of options, issue of shares pursuant to exercise of options. Subsequently, the issued shares may be sold by the employee. The stages are explained in more detail below:

Stage 1: Grant of ESOPs

ESOPs are granted by a company to an employee pursuant to an ‘ESOP scheme’. An ESOP scheme is a scheme usually prepared by a Compensation Committee, which is a committee that consists of specified members of the board of directors of a company.

ESOPs may be granted by the board, or a committee of the board, based on certain parameters determined by them (which could ideally include both performance-related criteria and the period of time for which the employee has worked for the company) to employees.

Stage 2: Vesting of ESOPs

ESOPs can be granted to those employees who participate in an ESOP Scheme. The compensation committee can grant the ESOPs in tranches, with each tranche being called a 'Plan Series'. The committee is also free to decide the vesting dates, the manner of vesting, and the employees to whom ESOPs may vest. For example, assume that there is a stock option scheme (ESOP Plan A) which comprises of 400,000 stock options. The compensation committee could decide to grant all the options equally over a period of 2 years, with four intervals of 6 months each, i.e. in 4 tranches.(Note: As per SEBI Guidelines (applicable only to listed companies), majority of the members of the Compensation Committee must be ‘independent directors’ in case of listed companies). The vesting period may be specified as 3 years from the date of the grant. The vesting could also be made conditional upon fulfilment of certain performance based criteria. Assuming that the performance based criteria have been met by the employee, the table below shows how ESOPs may vest:

Date of Grant

No. of Options Granted

Vesting Date

1 March 2009


1 March 2012

1 September 2009


1 September 2012

1 March 2010


1 March 2013

1 September 2010


1 September 2013


Stage 3: Exercise of ESOPs and issue of shares

After ESOPs have vested, the employee has a certain time period within which he may exercise the options that have vested in him. The company is bound to issue shares pursuant to the exercise of the options.

Note that the grant of an ESOP does not lead to ownership of the shares of a company. An employee has the benefits of ownership of the shares only after exercise of the option. However, that does not imply that the employee has the right to exercise his option for an infinite time, after the options have vested in him. An ESOP scheme should ideally specify the time period within which the options that have vested in an employee, may be exercised.

Most importantly, if the options are not exercised within specified time, under law they expire.

Key concepts an entrepreneur or startup advisors should know while structuring an ESOP Plan

A startup entrepreneur must have a sound understanding of certain concepts so that he can guide his company to create an ESOP Plan that suits the requirements of his business. The variables for each of these concepts can be customised as required. The essential concepts are explained below:

i. Eligibility - one should be careful about defining eligibility criteria. One important criterion is the time one must spend in employment before becoming eligible for ESOP.

ii. Date of grant and vesting period

The company is free to decide a minimum vesting period, of 1 year or more, between the grant of the ESOP, and the vesting of the option. In the example above, the vesting period was 3 years. The option cannot be exercised by an employee until it has vested in him.

iii. Lock-in period on shares

A company can specify a lock-in period for the shares issued or allotted pursuant to exercise of the stock options. Specifying a minimum lock-in period would not allow the employees from transferring shares issued after exercising the option, and hence would prevent or defer realization of the benefits of the ESOP. A lock-in period also adds the risk that the price of the shares may fall down at a later point in time and hence their value post lock-in may be adversely affected.

iv. Number of shares that will be issued to employees

Issuance of ESOPs dilutes, that is, reduces the shareholding percentage of the other shareholders of a company, so companies usually limit ESOPs such that the maximum number of shares issued, if all ESOPs were exercised, would range between 1 to 5% of all shares of the company. Further, limits may also be placed on the percentage of shareholding that an individual shareholder may acquire pursuant to exercise of the options. These limits are specified in the shareholder’s resolution authorizing issue of shares, and in the stock option scheme devised by the compensation committee.

v. Aggregate number of shares that can be issued to foreign employees
Indian companies often have foreign employees on their payroll, for the technical expertise that they bring in. The aggregate number of shares issued to a non-resident employee (the term non-resident is defined under the Foreign Exchange Management Act, 1999 (FEMA) cannot exceed 5% of the issued capital of the company.

 Under FEMA, a non-resident is defined as :
  1. Any person or body corporate registered or incorporated outside India;
  2. person who is not resident in India i.e. a person who stays outside India or has otherwise gone out of India i) for or on taking up employment outside India , or ii) for carrying on a business or vocation outside India, or iii) for any other purpose, in such circumstances as would indicate his intention to stay outside India for an uncertain period; or
  3. a person who stays in India for a purpose other than i) taking up employment in India, or ii) for carrying on in India a business or vocation India, or iii) any other purpose, in circumstances which indicate that he intends to stay in India for an uncertain period.



vi.  Effect of changes in capital structure

Changes in capital structure of a company can occur due to various corporate actions such as mergers, amalgamations, stock splits, bonus issue, rights issue, restructuring of the company, etc. These changes lead to alterations in the issued capital or the number of shares of the company, and require corresponding adjustments to ESOPs, else they would lead to variation in employees’ shares, from the percentage promised.  Hence, adjustments are necessary to restore employees to a position which is equivalent to the pre-change position. The adjustment to the ESOP, based on the change in capital structure is mentioned below:

  • Change before grant – The Compensation Committee can adjust the number of options granted as per its discretion or as per a specified formula.
  • Change after grant but before exercise – The number of shares granted pursuant to the exercise of the options would be adjusted to give him such percentage of shares as he would have had if the change had not taken place.
  • Change after exercise of the option – The employees who have exercised their options and own shares shall be eligible for the same adjustments as applicable to the other shareholders. In fact, after exercise of option, the employees get the same rights as any other ordinary shareholder.

    vii.    What happens to ESOPs if for some reason an employee ceases employment?

An employee may cease to be in employment for various reasons and it is important to understand how the cessation of employment relates to the ESOP package that the employee was offered. Some of the common causes of cessation and the manner in which the ESOP should be impacted is listed below:



Where the employee is not at fault



Reason for cessation

Consequence on ESOP


Death or disablement


All options granted uptil the date of death or disablement will vest immediately on the date of superannuation.


These options must be exercised within the earlier of a specified time period (such as, say 12 months, which must be specified in the ESOP scheme), or the prescribed time period that was originally fixed for exercise of the options.


The options may be exercised by the nominee, beneficiary, the legal heir or the legal guardian of the employee (as the case may be)


Resignation of the employee (where there is no dismissal by the organization)


Options that have not vested at the date of resignation or termination would expire.


Options that have vested must be exercised within the earlier of a specified time period, e.g. 1 month, and the time period that was originally fixed for the exercise of the option. All options that are not exercised within such time would lapse.



Superannuation/ retirement


All options granted up till the date of superannuation will vest immediately on the date of superannuation. These options must be exercised within the earlier of a specified time period (such as, say 12 months, which must be specified in the ESOP scheme), or the prescribed time period that was originally fixed for exercise of the options.



Fault-based reasons for termination (e.g. misconduct, non-achievement of targets, etc.)



Reason for cessation

Consequence on ESOP


Where the employment of an employee may be terminated for a reason, e.g. not meeting targets, misconduct, fraud, breach of an employment obligation such as confidentiality, etc. (Note: The circumstances on which a dismissal would qualify as a dismissal for cause may be specified in the ESOP scheme. The responsibility to determine whether an employee has been terminated for cause may be placed on the Compensation Committee.)



All options, whether vested or not, shall lapse immediately and the employee cannot exercise any rights in respect of the options.

Note: Employment contracts often specify a notice period for termination of employment by the employer, even where there are bona fide reasons for such termination. In such cases, if the date of termination is not defined, the employee, may argue that he has a right to exercise options until the expiry of the notice period. This is against the interest of the company. Hence, it is important to carefully define the date of termination of the employment – it can be defined to mean the date on which the notice of termination is served on the employee.


 viii. ESOPs to foreign employees of Indian companies

Indian companies often hire foreign employees for their technical expertise. They also hire foreigners for their offshore subsidiaries. Such employees may also be given stock options. Issue of stock options by Indian companies to their foreign employees is governed by the Foreign Exchange Management Act, 1999 (FEMA). As per RBI’s Master Circular on Foreign Investment in India, 2012 pursuant to the FEMA, an Indian company may issue shares under ESOPs to its employees or employees of its joint venture or wholly owned subsidiary abroad who are resident outside India. The face value of the shares to be allotted under the scheme to the non-resident employees should not exceed 5 per cent of the paid-up capital of the issuing company.


However, citizens of Pakistan are not permitted to hold shares pursuant to ESOPs, and citizens of Bangladesh can own shares pursuant to exercise of ESOPs only with the prior approval of the Foreign Investment Promotion Board (FIPB).  


ix. Issuing ESOP for employees of a subsidiary

ESOPs can also be granted by a company to employees of its holding or subsidiary company. So, for example, if a company which manufactures LED screens for desktops and laptops (Holdco) has a subsidiary which is into manufacturing mobile LCDs (Subco), the Holdco could issue ESOPs to Subco’s employees. This can help in incentivising employees if the Holdco has a higher valuation, although they are working for Subco.


Test Your Skills Now!
Take a Quiz now
Reviewer Name