Everything founders need to know about structuring and managing ESOPs.
ESOP Guide for Indian Founders
Employee Stock Ownership Plans (ESOPs) are one of the most powerful tools for startups to attract and retain top talent. This guide covers everything from setting up an ESOP pool to tax implications for both the company and employees.
What are ESOPs?
ESOPs give employees the right to purchase company shares at a predetermined price (exercise price) after a specified period (vesting period). They align employee interests with company growth.
Setting Up an ESOP Pool
#### Step 1: Determine Pool Size
Typical ESOP pool: 10-15% of fully diluted equity
Pre-seed stage: 10% is standard
Series A: 12-15% is common (may need top-up)
Series B+: 15-20% including refresher grantsNote: Investors often require the ESOP pool to be set up or topped up before their investment (so the dilution comes from founders, not investors).
#### Step 2: Board and Shareholder Approval
Required resolutions:
Board resolution approving the ESOP scheme
Special resolution passed by shareholders (75% majority)
File MGT-14 with ROC within 30 days#### Step 3: Create the ESOP Scheme Document
The scheme must include:
Total number of options to be granted
Eligibility criteria
Vesting schedule and conditions
Exercise price and exercise period
Lock-in period after exercise (if any)
Method of valuationVesting Schedules
The most common vesting structures in India:
Standard 4-Year Vesting with 1-Year Cliff:
Year 1: 0% (cliff period, nothing vests)
After Year 1: 25% vests immediately
Remaining 75%: Vests monthly or quarterly over next 3 yearsExample: If an employee is granted 1,000 options:
After 12 months: 250 options vest
Month 13 onwards: ~21 options vest per month
After 48 months: All 1,000 options are vestedOther structures:
3-year vesting: Faster vesting for senior hires
Back-loaded vesting: More options vest in later years (e.g., 10%, 20%, 30%, 40%)
Performance-based vesting: Options vest upon achieving specific milestonesExercise Price
The exercise price determines how much the employee pays to convert options into shares.
Common approaches:
Face value (INR 10): Most employee-friendly, maximum benefit to employee
Fair Market Value (FMV): No tax at exercise, gain only at sale
Discounted FMV: A middle groundImportant: The exercise price must be determined by a registered valuer as per Rule 11UA of Income Tax Rules.
Tax Implications
#### For Employees
At Exercise (Perquisite Tax):
The difference between FMV on exercise date and exercise price is taxed as salary income (perquisite)
Tax rate: As per employee's income tax slab (up to 30% + cess)
Employer must deduct TDS on this amountAt Sale (Capital Gains):
Short-term (held less than 2 years from exercise): Taxed at slab rates
Long-term (held more than 2 years from exercise): Taxed at 12.5% (after INR 1.25 lakh exemption)Startup benefit (Section 80-IAC eligible startups):
Employees of DPIIT-recognized startups can defer perquisite tax for up to 4 years from exercise or until they leave the company or sell shares (whichever is earliest)#### For the Company
ESOP grants are not a direct expense at grant time
The company must deduct TDS on perquisite value at exercise
ESOPs must be valued and disclosed in financial statements as per Ind AS 102How Much ESOP to Give
Typical ranges by role and stage:
| Role | Seed Stage | Series A | Series B+ |
|------|-----------|----------|-----------|
| CTO / Co-founder level | 2-5% | 1-3% | 0.5-2% |
| VP / Director | 0.5-1.5% | 0.25-1% | 0.1-0.5% |
| Senior Engineer | 0.1-0.5% | 0.05-0.25% | 0.02-0.1% |
| Mid-level Employee | 0.05-0.15% | 0.02-0.1% | 0.01-0.05% |
| Junior Employee | 0.01-0.05% | 0.005-0.02% | 0.002-0.01% |
Common Mistakes to Avoid
Not setting up a formal scheme: Verbal promises are not enforceable
Granting too much too early: Keep reserves for future key hires
Not explaining value to employees: Employees should understand what their options are worth
Ignoring tax implications: Employees may face unexpected tax bills at exercise
No buy-back policy: Without liquidity events, ESOPs have limited perceived value
Forgetting to top up the pool: After each funding round, review if the pool needs expansionLiquidity for ESOP Holders
Since startup shares are not publicly traded, consider these liquidity options:
Secondary sales: Allow employees to sell vested shares to incoming investors
Company buy-back: Company repurchases shares at fair value
ESOP buy-back programs: Periodic programs (e.g., annually) where company offers to buy vested options
IPO or acquisition: Ultimate liquidity event