How to Issue ESOPs in an Indian Private Company: Rule 12 Checklist

Who can receive ESOPs?

Rule 12 allows options for permanent employees working in India or abroad, directors (whole-time or not, but not independent directors), and employees of a holding, subsidiary or associate company. Promoters, members of the promoter group and directors who hold more than 10% of the shares, directly or through relatives or companies, are excluded.

For a DPIIT-recognised startup, that exclusion does not apply for ten years from incorporation. This lets founder-directors receive options during the early years, which is often used to balance founder and team equity.

What must the ESOP scheme and resolution contain?

The explanatory statement to the special resolution must disclose the total options to be granted, identification of eligible classes of employees, appraisal process, vesting requirements and maximum period, exercise price or formula, exercise period, lock-in if any, the maximum options per employee and the accounting policies used. Shareholders also approve the size of the pool, commonly expressed as a percentage of fully diluted capital.

• Pool size and classes of eligible employees
• Vesting schedule (minimum one year)
• Exercise price and exercise window
• Treatment on resignation, termination or death
• Lock-in after exercise, if any
• Buyback or liquidity provisions

How do grants and vesting work?

After approval, the board or a compensation committee grants options through grant letters stating the number of options, exercise price and vesting schedule. A typical startup schedule is four years with a one-year cliff. Options cannot be transferred, pledged or hypothecated, and they lapse if not exercised within the window. If an employee dies, all options vest in the legal heirs immediately; on permanent incapacity they vest in the employee.

What tax applies?

Employees pay tax at two points: when they exercise, the difference between fair market value on the exercise date and the exercise price is taxed as a salary perquisite, and the employer deducts TDS; when they later sell, any gain over that fair value is a capital gain. Fair value of unlisted shares is set by a SEBI-registered merchant banker.

Employees of eligible startups (those certified by the Inter-Ministerial Board) could defer the tax on the perquisite under the 1961 Act until the earliest of 48 months from the end of the relevant year, sale, or leaving the company. Confirm how the 2025 Act carries this deferral before relying on it.

Filings and records

The company files MGT-14 for the special resolution within 30 days, maintains Form SH-6 (register of ESOPs), discloses ESOP details in the board's report and files PAS-3 within 30 days of allotting shares on exercise. Check authorised capital before large exercises and increase it with SH-7 if needed.

Common mistakes

Early-stage companies often promise options in offer letters without an approved scheme, set vesting shorter than one year, or grant options to a 10%-plus founder after the startup window ends. Others forget that ESOP cost is an accounting expense, which surprises founders at audit. Fix the scheme before you hire, not after.

Step by step

1. 1Decide pool and terms

   Agree pool size, vesting, exercise price and leaver rules.

2. 2Draft scheme

   Prepare the ESOP scheme with Rule 12 disclosures.

3. 3Board approval

   Board approves the scheme and calls a general meeting.

4. 4Special resolution

   Shareholders approve the scheme by special resolution.

5. 5File MGT-14

   File within 30 days of the resolution.

6. 6Issue grant letters

   Grant options and record them in Form SH-6.

7. 7Handle exercise

   Collect exercise price, deduct TDS, allot shares and file PAS-3.