What Is an ESOP Policy (Employee Stock Ownership Plan) with an Example?
An ESOP, or Employee Stock Ownership Plan, gives employees shares in the company, making them partial owners. Companies use ESOPs to keep employees motivated, loyal, and on the job while saving money. ESOPs connect employees’ goals with the company’s growth by tying rewards to how well the company does. ESOPs are often used by new and growing businesses to attract top talent, make employees feel like they own the company, and encourage them to remain committed to the company’s long-term success.
Example of ESOP policy
Imagine a startup grants an employee 1,000 stock options at an exercise price of ₹100 per share, while the current market value is also ₹100. These shares vest over 4 years (250 shares each year). After 4 years, the company’s share price rises to ₹400.
- The employee exercises all 1,000 shares at ₹100 each = ₹1,00,000
- market value is ₹400 × 1,000 = ₹4,00,000
- profit (wealth created) = ₹3,00,000
Thus, the employee benefits from ownership and wealth creation while the company retains a loyal, motivated worker.
Applying for ESOP Policy Click Here…
How does an ESOP policy work?
An ESOP policy gives eligible employees the option to buy or get company shares at a set price, which is often lower than the market price. These shares usually vest over time, which means that employees gradually gain ownership. After they are vested, employees can use their options, keep their shares, or sell them when they are allowed to. This system gives employees bonuses for their work and makes sure that their goals are in line with the company’s financial success and growth.
What are the main objectives of an ESOP policy?
Here are the main objectives of an ESOP policy:
- To give employees a sense of ownership in the company.
- To motivate and retain skilled talent.
- To align employees’ efforts with company growth and profitability.
- To serve as a non-cash compensation tool, especially for startups.
- To improve loyalty and reduce attrition.
- To share the wealth created by the company with its workforce.
What are the advantages of ESOP Policies?
By offering both monetary benefits and prospects for long-term growth, an ESOP policy helps both businesses and employees. It increases retention, fortifies workplace culture, and fosters trust between employers and workers.
Key Advantages:
- Provides employees with ownership and wealth creation opportunities.
- Boosts motivation, productivity, and commitment.
- Helps companies retain and attract top talent.
- Reduces the need for high cash salaries in startups.
- Aligns employee performance with company success.
- Enhances loyalty and reduces employee turnover.
What are the tax implications of an ESOP policy in India?
In addition to providing employees with ownership benefits, an ESOP policy entails certain tax obligations. In India, ESOPs are taxed at two distinct points in time: upon the sale of shares and upon their exercise.
Key tax implications:
- When employees exercise their ESOPs, the difference between the fair market value and the exercise price is taxed as a perquisite under salary income.
- When employees sell their shares, the profit is taxed as capital gains.
- Short-term capital gains tax applies if shares are sold within 12 months, while long-term capital gains tax applies if sold after 12 months.
- Startups registered under DPIIT may get deferred tax benefits for ESOPs in certain cases.
How is an ESOP policy structured and valued?
The company’s board and shareholders must approve a formal plan for an ESOP policy. It sets the eligibility, vesting period, exercise price, and number of shares that employees can get. Employees usually get stock options that become available over time, which keeps them committed for the long term.
Fair market value (FMV) is used to figure out how much ESOPs are worth. A registered valuer usually does this. This makes sure that prices are clear, taxes are paid, and employees get their fair share of benefits.
What challenges do companies face while implementing an ESOP policy?
An ESOP policy can be highly rewarding, but companies often face challenges during its implementation. Designing, managing, and sustaining such a plan requires careful planning and compliance.
Key challenges include:
- Determining the right valuation of shares to ensure fairness.
- Managing complex legal, tax, and regulatory requirements.
- Balancing dilution of ownership with company control.
- Educating employees about how ESOPs work and their benefits.
- Handling administrative costs and documentation.
- Ensuring the long-term sustainability of the policy as the company grows.
How is an ESOP policy different from stock options or profit-sharing?
| Aspect | ESOP Policy | Stock Options | Profit-Sharing |
| Ownership | Employees get actual company shares | Employees receive a share of profits only | Long-term, with a vesting period |
| Wealth Creation | Linked to company growth and share value | Linked to growth when exercised | Depends only on annual profits |
| Benefit Type | Flexible, based on the profit pool | Long-term, exercised after vesting | Short-term, usually yearly |
| Structure | Legally structured with valuation & compliance | Contractual arrangement with exercise price | Flexible, based on profit pool |
| Impact on control | May dilute company ownership | May dilute if exercised | No dilution of ownership |
What are the legal and compliance requirements of an ESOP policy?
To safeguard the company and its employees, an ESOP policy in India must adhere to stringent legal and compliance requirements. Income tax laws, the Companies Act of 2013, and Sebi regulations (for listed companies) are the main laws that govern these rules.
Key legal and compliance requirements:
- Shareholder approval is mandatory through a special resolution.
- ESOP schemes must clearly define eligibility, vesting period, and exercise price.
- Listed companies must comply with SEBI (share-based employee benefits) regulations.
- Companies must maintain proper records and file necessary returns with regulators.
- Tax compliance is required on both perquisite value (at exercise) and capital gains (on sale).
- Independent valuation of shares is required for fair market value determination.
How can startups design an effective ESOP policy?
An ESOP policy can be a powerful tool for startups to reward employees and build loyalty without high salary costs. Designing it effectively requires clarity, compliance, and long-term vision.
Startups can design an effective ESOP policy:
- Define clear eligibility criteria for employees.
- Set a reasonable vesting period to encourage retention.
- Decide on an attractive but fair exercise price.
- Align the ESOP structure with the company’s growth stage and funding plans.
- Ensure compliance with legal and tax rules.
- Explain the value and benefits of ESOPs to employees in simple terms.
- Review and update the policy as the startup scales.
What is the future of ESOP policies in India and globally?
More and more companies are realising how important ESOP policies are for keeping employees and making money. This is a good sign for the future of ESOP policies in India and around the world. In India, more and more startups and growing businesses are using ESOPs to hire people while saving money. Globally, ESOPs are becoming a common way to make sure that employees’ interests are in line with the company’s performance. As more people learn about them, laws that support them, and employees want to own them, ESOPs are likely to grow even more and become more flexible.
What is the ESOP Policy Registration process?
| step | process | Who is responsible |
| 1 | Draft the ESOP scheme (eligibility, vesting, exercise price, etc.) | company management/hr |
| 2 | Get board approval for the draft scheme | board of directors |
| 3 | obtain shareholder approval through a special resolution | shareholders in a general meeting |
| 4 | Comply with Companies Act, 2013 and SEBI regulations (for listed firms) | legal & compliance team |
| 5 | file necessary forms with ROC (such as MGT-7, pas-3) | company secretary / legal team |
| 6 | Appoint a registered valuer to determine the fair market value of shares | independent valuer |
| 7 | grant ESOPs to eligible employees | company management |
| 8 | maintain records and report in annual filings | company secretary |
Who is eligible for the ESOP policy of Listed company?
In a listed company, ESOP policy eligibility is defined under the Companies Act, 2013 and SEBI (share-based employee benefits) regulations. Generally, it covers employees and directors but excludes certain categories.
Eligible for ESOP in a listed company:
- permanent employees of the company (in India or abroad)
- directors of the company, including whole-time and part-time directors,
- employees of the holding company or subsidiary company
Not eligible for ESOP:
- promoters or members of the promoter group
- directors holding more than 10% of the company’s equity (directly or indirectly)
Conclusion.
An ESOP policy is more than just a perk for employees; it’s a way to connect personal growth with the success of the company. Companies can inspire loyalty, improve performance, and keep good workers by giving them ownership. There are problems like compliance and valuation, but the long-term benefits are worth it. As more and more people in India and around the world accept ESOPs, they will be a big part of creating a future where employees and companies grow together.
What is an ESOP, and how does it work?
An ESOP (employee stock ownership plan) lets employees own company shares. Employees receive stock options that vest over time, which they can later buy at a set price and sell for profit. This motivates employees and links their success with company growth.
Is ESOP included in CTC?
Yes, ESOPs can be included in CTC (cost to company), but not always. Many companies, especially startups, show the notional value of ESOPs in the CTC to highlight the overall benefits offered. However, unlike salary, ESOPs are conditional – they vest over time and can only be exercised later. So, while ESOPs may appear in CTC, employees get actual value only when shares are vested, exercised, and sold.
What are the disadvantages of ESOP?
Disadvantages of ESOP:
1. Uncertain returns as value depends on company performance.
2. Tax burden at exercise and sale.
3. Liquidity issues in unlisted companies.
4. Ownership dilution for existing shareholders.
5. Complex legal and compliance requirements.
Can I sell my ESOP shares?
Yes, you can sell your ESOP shares, but only after they are vested and you have exercised them (purchased at the exercise price). If the company is listed, you can sell them on the stock exchange. If it is unlisted, you may sell them back to the company, during a buyback, or to investors when allowed. The ability to sell depends on company policies and regulatory rules.
Is ESOP good or bad?
Why ESOP is good:
1. Gives employees ownership and wealth-building opportunities
2. Motivates and retains talent
3. Aligns employee goals with company success
Why ESOP can be challenging:
1. Value depends on company performance, so returns are uncertain
2. May create tax and liquidity issues for employees
3. Involves compliance and ownership dilution for companies
What happens to ESOP when you leave?
When you leave a company, what happens to your ESOP depends on your vesting status and the company’s policy:
1. vested ESOPs: You can exercise them within the exercise period (usually a few months). After that, unexercised options lapse.
2. Unvested ESOPs: These are forfeited and returned to the company.
3. If the company is listed, exercised shares can be sold in the market.
4. If the company is unlisted, you may have to wait for buyback, ipo, or investor exit to sell shares.
Can I cash out my ESOP early?
Generally, you cannot cash out ESOPs early because they come with a vesting period. You can only exercise (buy) the options once they vest. After exercising, if the company is listed, you can sell the shares anytime. If it’s unlisted, you may need to wait for events like a company buyback, funding round, or ipo to cash out.
What is a good amount of ESOP?
A “good” amount of ESOP depends on your role, company stage, and growth potential rather than a fixed number. generally:
early-stage startups: senior employees may get 0.5% – 2% equity, while mid-level may get 0.1% – 0.5%.
growth-stage companies: percentages are smaller (like 0.01% – 0.1%) but can still be valuable if the company scales.
The “goodness” also depends on valuation, vesting period, liquidity options, and exercise price.
So, a good ESOP offers fair ownership, realistic vesting, and clear liquidity opportunities.