ESOP for startups in India: rules, vesting and tax

An ESOP lets a startup pay part of its team in future ownership instead of cash it doesn't have yet. The idea is simple. The paperwork, the vesting floor and the timing of tax are set by law, and investors check all three.

This guide covers what the Companies Act says, how vesting and cliffs work, how the tax falls under the Income-tax Act, 2025, and what a diligence lawyer will ask to see.

What is an ESOP under the Companies Act?

Under section 2(37) of the Companies Act, 2013, an employees' stock option is a right given to directors, officers or employees to buy or subscribe for the company's shares at a future date at a pre-determined price. Section 62(1)(b) lets a company issue shares under such a scheme.

The Companies Act on India Code ties that issue to a special resolution and to conditions set by rules. Private companies have some exemptions from these requirements, so ask your company secretary which resolution your company needs.

For an unlisted startup, the conditions sit in rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Listed companies follow SEBI's Share Based Employee Benefits and Sweat Equity Regulations, 2021, which apply to companies whose equity shares are listed on an Indian stock exchange.

Who can hold options

Rule 12, as reproduced with its amendment notes, covers permanent employees in or outside India and directors, but not independent directors. It excludes promoters, the promoter group and directors holding more than 10% of the equity.

A startup as defined by the DPIIT is exempt from those exclusions for ten years from incorporation. That is why founders of young companies can be granted options, while founders of older ones usually can't.

How do vesting and cliffs work for ESOPs in India?

Vesting is the point at which a granted option can be exercised. Rule 12 sets a floor: at least one year must pass between grant and vesting. That works like a built-in one-year cliff. Beyond it, the scheme decides the schedule, such as yearly or monthly instalments, and any performance conditions.

Other rule 12 terms worth knowing before you draft:

• Options can't be transferred, pledged or mortgaged, and only the employee can exercise them.
• Holders get no dividend or vote until shares are actually issued.
• On resignation or termination, unvested options lapse; vested ones can be exercised within the period the scheme sets.
• On death or permanent incapacity, all options granted up to that date vest.
• The company sets the exercise price, in line with its accounting policies, and keeps a register of options in Form SH-6.

The exercise window after someone leaves is where schemes differ most. A short window can leave a departing employee holding vested options they can't afford to exercise in time.

How big is an ESOP pool at Indian startups?

There is no official Indian dataset on pool size. One recent benchmark is a survey of 160 startups by Saison Capital, XA Network and Carta, reported by ET CFO in November 2024: the median pool grew from 9% in 2021 to 12.6% in 2024. It isn't described as India-only, so treat it as a regional benchmark.

The same survey found 78% of the startups offered ESOPs in 2024, up from 59% in 2021. Only 14% of founders said they felt knowledgeable about the tax side, which is the most useful warning in it.

Pool size is a negotiation, not a rule. New investors may ask for the pool to be created or topped up before their money comes in, which puts that dilution on existing holders. The ESOP pool checks investors run explain who pays for a top-up and how to read it in a term sheet.

How are ESOPs taxed in India?

ESOPs are taxed twice. At exercise, the gap between the share's fair market value on the exercise date and the price the employee pays is a salary perquisite, taxed at normal rates with tax deducted by the employer. Any gain on a later sale is taxed separately as capital gains.

Since 1 April 2026 the rule sits in the Income-tax Act, 2025. Section 17(1)(d) treats specified securities and sweat equity shares allotted at no cost or at a concessional rate as a perquisite. Section 17(2)(h) values it at fair market value on the exercise date, less the amount the employee paid.

The deferral for eligible start-ups

Tax at exercise hurts because the employee gets shares, not cash. For an eligible start-up, sections 289(3) and 392(3) move the payment date. Tax becomes due within 14 days of the earliest of three events: 60 months after the end of the relevant tax year, the sale of the shares, or the employee leaving that employer.

The catch is the definition. An eligible start-up here is one referred to in section 140: a company or LLP incorporated on or after 1 April 2016 and before 1 April 2030, with turnover up to Rs 100 crore, holding a certificate of eligible business from the Inter-Ministerial Board.

DPIIT recognition alone doesn't qualify a company, a point covered in what DPIIT recognition does for fundraising. And the tax is still worked out at the rates for the year of allotment: deferral changes when the money is due, not how much.

This is a summary of the statute, not tax advice. A chartered accountant should check how it applies to your scheme and to each grant.

An ESOP is only as good as its paperwork: a grant with no resolution, no register and no filing is a promise, not an option.

What do investors check in an ESOP scheme?

Investors check that the scheme exists on paper and that the numbers in your deck agree with it. They ask for the resolution, the scheme document, the SH-6 register, grant letters and a return of allotment for every exercise, then add every option, granted or not, to the fully diluted cap table.

• Approval: the resolution approving the scheme and any later change. Rule 12 lets terms of unexercised options change only by special resolution, and not to the holders' disadvantage.
• Grants: a letter for each grant that agrees with the register, with dates that respect the one-year vesting floor.
• Exercises: a return of allotment, Form PAS-3, for every allotment of shares on exercise.
• Founder grants: if founders hold options, the startup exemption from the promoter exclusion must have applied on the grant date.
• Tax promises: if employees were told their tax is deferred, the company's Inter-Ministerial Board certificate.
• Pool: the unallocated balance, and whether the new round expects a top-up.

When the spreadsheet and the filings disagree, investors trust the filings. Cleaning up your cap table before a fundraise walks through reconciling the two, and the due diligence document checklist shows where ESOP papers sit in a data room.

What should founders set up first?

Set up the scheme before you promise options in offer letters. Draft the scheme, pass the resolution, open the SH-6 register and size the pool with your next round in mind. Then issue grant letters that state the number of options, the exercise price, the vesting schedule and the exercise window after leaving.

Explain the tax to employees in plain words, including whether the deferral applies. Few founders feel sure of ESOP tax, so a short written note with a worked example, reviewed by a chartered accountant, saves a hard conversation at exercise time.

Questions

What is an ESOP in a startup in India?

An ESOP, or employee stock option plan, gives employees and directors the right to buy the company's shares at a future date at a price fixed in advance. Section 2(37) of the Companies Act, 2013 defines the option, and section 62(1)(b) lets a company issue shares under such a scheme.

What is the minimum vesting period for ESOPs in India?

For unlisted companies, rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 requires at least one year between the grant of an option and its vesting. Beyond that floor, the scheme sets the schedule, such as yearly or monthly instalments and any performance conditions.

How are ESOPs taxed in India?

Twice. At exercise, the fair market value of the shares on the exercise date minus the price paid is taxed as a salary perquisite under section 17 of the Income-tax Act, 2025. A later sale is taxed separately as capital gains. A chartered accountant should check your own case.

Can a startup defer ESOP tax for employees?

Yes, if it is an eligible start-up under section 140 of the Income-tax Act, 2025, which needs an Inter-Ministerial Board certificate, not only DPIIT recognition. Tax is then due within 14 days of the earliest of 60 months after the tax year ends, sale of the shares, or leaving the employer.

Can founders get ESOPs in India?

Rule 12 normally excludes promoters and directors holding more than 10% of the equity. A startup as defined by the DPIIT is exempt from that exclusion for ten years from incorporation, so founders can receive options in that window if the scheme allows it.

Sources: Government of India (India Code), The Companies Act, 2013, sections 2(37) and 62 · ca2013.com, Rule 12, Companies (Share Capital and Debentures) Rules, 2014 (rule text with amendment notes), checked 11 Nov 2026 · SEBI, Share Based Employee Benefits and Sweat Equity Regulations, 2021, amended up to 4 Dec 2025 · Ministry of Law and Justice, The Income-tax Act, 2025, Gazette of India, 21 Aug 2025 · ET CFO, Around 78% of startups offer ESOPs in 2024, a rise from 59% in 2021: Survey, 6 Nov 2024

For more on how startup funding works in India, read the MyStartupValley blog or visit mystartupvalley.com.