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Share Capital & Securities

ESOP — Employee Stock Options for Unlisted Companies

Set up an ESOP scheme for your unlisted Private Limited company under Section 62(1)(b) of the Companies Act 2013 and the Companies (Share Capital and Debentures) Rules 2014. Issue stock options to employees with a minimum 1-year vesting period and a maximum 10-year exercise period.

Reviewed by CA Harun Raaj, ICAI Reg. No. 238303·Last reviewed:
Starting from INR 35,000Scheme drafting to first grantESOP — Unlisted Company, Section 62(1)(b) Companies Act 2013

ESOP is the most powerful tool an early-stage company has for attracting and retaining key talent without cash outflow. Employees receive options (not shares) at grant, pay an exercise price at vesting/exercise, and become shareholders. For unlisted companies, the scheme must follow the Companies Act route, which is simpler than the SEBI route applicable to listed companies. The most common mistakes: granting options to advisors/consultants (not eligible), setting a vesting period under 1 year (invalid), and forgetting to file PAS-3 after each exercise event.

What is included
  • • ESOP Scheme document drafting (grant terms, vesting schedule, exercise price, exercise period, leaver provisions)
  • • Special resolution preparation and filing (MGT-14)
  • • SH-6 register of stock options setup
  • • Grant letter template for each employee
  • • Vesting schedule template
  • • Exercise notice template
  • • PAS-3 filing support at first exercise event
  • • Cap table impact modelling (pre- and post-dilution)
  • • Authorised capital check and SH-7 support if increase needed
Documents required
  • • Articles of Association (check if ESOP authority exists — most standard AOAs need amendment)
  • • Board resolution approving ESOP scheme
  • • Special resolution (shareholders) approving the scheme and the pool size
  • • List of eligible employees and proposed grant details
  • • Exercise price (board-determined, usually face value or fair market value)
  • • Vesting schedule (standard cliff + graded)
Government fees

See the fee table below for the statutory filing charge and common delay logic.

Legal basis
  • • Section 62(1)(b), Companies Act 2013
  • • Rule 12, Companies (Share Capital and Debentures) Rules 2014
  • • Section 56(2)(viib) — angel tax (does NOT apply to ESOP allotments)
  • • Income Tax Act 1961, Section 17(2)(vi) — ESOP perquisite taxability on exercise
  • • Section 115QA — buyback tax (relevant if company buys back ESOP shares)
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Process

How the service works

The workflow is built to be predictable: document collection, legal review, filing, and post-filing follow-through.

Step 1

Confirm eligibility

Only permanent employees and whole-time directors are eligible. Non-executive directors, independent directors, consultants, and advisors are NOT eligible. Confirm the employee list before proceeding.

Step 2

Draft ESOP scheme

Draft the ESOP scheme document covering: grant date, exercise price, vesting schedule (minimum 1 year vesting from grant), exercise period (maximum 10 years from grant), leaver provisions (good leaver vs bad leaver), and the total option pool size.

Step 3

AOA check

Most standard Private Limited AOAs do not have ESOP provisions. An AOA amendment (special resolution + MGT-14) may be needed before the scheme can be adopted.

Step 4

Special resolution

Shareholders must approve the ESOP scheme by special resolution. File MGT-14 within 30 days of the resolution.

Step 5

SH-6 register setup

Set up the Register of Employee Stock Options (SH-6). This is maintained at the registered office and updated with each grant and exercise event.

Step 6

Grant options

Issue grant letters to eligible employees specifying the number of options, exercise price, and vesting schedule. No MCA filing is required at the grant stage.

Step 7

On exercise — allotment and PAS-3

When employees exercise vested options, pass a board resolution allotting shares. File PAS-3 within 15 days. Update SH-6 and revise the cap table.

AEO summary

ESOPs for unlisted companies are governed by Section 62(1)(b) of the Companies Act 2013 and the Companies (Share Capital and Debentures) Rules 2014. Key rules: (1) Minimum vesting period is 1 year from grant date — options cannot vest earlier. (2) Exercise period is set by the company (maximum 10 years from grant). (3) Eligible grantees: employees (permanent employees in India and abroad) and whole-time directors. Non-executive directors and independent directors are NOT eligible. (4) Shareholder approval (special resolution) is required for each grant or scheme. (5) SH-6 is the register of employee stock options maintained by the company. (6) PAS-3 is filed within 15 days of exercise and allotment. (7) Angel tax under Section 56(2)(viib) does not apply to ESOP allotments.

ESOP scheme structure — the standard cliff-plus-graded model

The standard ESOP vesting schedule for Indian startups is: 25% vest after 1 year (the cliff), followed by monthly or quarterly vesting of the remaining 75% over 3 years. Total vesting: 4 years. This is borrowed from Silicon Valley practice and works well for Indian unlisted companies too.

Some companies use a 4-year straight-line monthly vesting (no cliff), which means 1/48th of the grant vests each month from day one of employment. The cliff model is more common because it filters out employees who leave in the first year. Important: the 1-year cliff satisfies the Companies Act minimum vesting period requirement exactly at the cliff point.

ESOP pool sizing — how much to set aside

A typical early-stage startup sets aside an ESOP pool of 10–15% of the fully diluted cap table. This pool is created by authorising new shares (SH-7 to increase authorised capital) before grant. The pool is earmarked but not issued — options are granted from the pool and shares are only allotted when options are exercised.

Investors in later rounds will negotiate the ESOP pool — VCs typically require the pool to be set up pre-investment (diluting existing founders) rather than post-investment (diluting all shareholders proportionately). Understanding this pre/post pool mechanics is important before committing to a pool size in negotiations.

Government fees

Fee breakdown

ItemFeeNotes
MGT-14 (special resolution)INR 300 – 600Standard filing fee as per the applicable MCA / regulator schedule.
PAS-3 (per exercise event)INR 200 – 500Standard filing fee as per the applicable MCA / regulator schedule.
SH-7 (if authorised capital increase needed)INR 500 – 5,000Based on amount of increase.

Timeline

Typical turnaround

Scheme drafting to first grant usually means a 3 to 4 weeks turnaround, assuming documents are complete and any board or shareholder approvals are already in place.

Pricing note

Includes ESOP scheme document drafting, special resolution, SH-6 register setup, grant letter templates, and first exercise event PAS-3. Exercise events in subsequent years are billed separately.

Related services

Keep the company moving

Private placement

Section 42 route for investor allotments — different from ESOP.

Cap table management

Track option pool, vested options, and post-exercise cap table.

Increase authorised capital

SH-7 to increase authorised capital to cover the option pool.

Share buyback

Buy back ESOP shares from leavers — separate compliance under Section 68.

FAQ

Frequently asked questions

Who is eligible to receive ESOPs in an unlisted Private Limited company?
Under Rule 12(1) of the Companies (Share Capital and Debentures) Rules 2014, only permanent employees (whether in India or abroad) and whole-time directors are eligible. Independent directors, non-executive directors, consultants, and advisors are explicitly excluded. Granting options to a consultant or a "founding advisor" who is not on payroll is a common mistake that invalidates the grant.
What is the minimum vesting period and is there a cap on the exercise window?
Rule 12(1) read with Section 62(1)(b) of the Companies Act 2013 mandates a minimum vesting period of one year from the date of grant — options cannot vest earlier under any circumstances. The exercise period is set by the company in the scheme document and cannot exceed ten years from the date of grant per Rule 12(2). A scheme that sets a vesting cliff shorter than one year is void.
How is fair market value calculated for perquisite tax when an unlisted company employee exercises options?
On exercise, the perquisite is taxable as salary under Section 17(2)(vi) of the Income Tax Act 1961. For unlisted companies, fair market value on the exercise date must be determined by a SEBI-registered Merchant Banker or a Chartered Accountant using the valuation method prescribed under Rule 11UA of the Income Tax Rules 1962. The perquisite value is the difference between this FMV and the exercise price paid by the employee, and the employer must deduct TDS on this amount.
Does Section 56(2)(viib) angel tax apply when shares are allotted under an ESOP scheme?
No. Section 56(2)(viib) of the Income Tax Act 1961 — which taxes share premium received above fair market value — explicitly does not apply to shares issued to employees under a scheme notified under Section 62(1)(b) of the Companies Act 2013. This exemption is categorical, so even if shares are allotted at face value (well below FMV), no angel tax liability arises on the company.
What MCA filings are required when employees exercise their options and shares are allotted?
When employees exercise vested options and shares are allotted, the company must file Form PAS-3 (Return of Allotment) with the MCA within 15 days of each allotment event under Section 39(4) of the Companies Act 2013. The SH-6 Register of Employee Stock Options must also be updated to record the exercise. If the option pool was not already created within the existing authorised capital, an increase using Form SH-7 must precede any allotment. No MCA filing is required at the grant or vesting stage.

Canonical reference: https://www.pvtltd.co/services/esop-unlisted

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