Employee Stock Ownership Plans (ESOPs) are a game-changer for startups looking to attract talent, boost morale, and align teams with long-term goals—all without draining cash reserves. But how do ESOPs work, what’s their tax impact, and how do you issue them? In this blog, we’ll explore the importance of ESOPs, break down their taxation in India, and outline the process of issuing ESOPs, complete with real-world case studies to inspire your startup journey.

Why ESOPs Matter for Startups

ESOPs grant employees the right to buy company shares at a predetermined price, turning them into stakeholders. Here’s why they’re critical:

1. Talent Magnet: In a competitive market, ESOPs sweeten the deal for top hires, especially when cash salaries can’t compete with big corporations.
2. Retention Boost: Employees stay longer, motivated by the promise of future gains as the company grows.
3. Cash Conservation: Startups can reward teams without upfront payouts—a lifeline for early-stage ventures.
4. Aligned Vision: Ownership fosters a sense of responsibility, driving employees to think like founders.

At The StartupLab, we’ve seen ESOPs transform startups into talent hubs while preserving equity for growth. But with rewards come tax considerations—let’s dive in.

Taxation on ESOPs in India

ESOP taxation occurs at two stages:

1. Exercise Stage: When employees exercise their option (buy shares), the difference between the exercise price and the fair market value (FMV) is taxed as a perquisite under “salary” in the Income Tax Act, 1961. Tax is deducted at source (TDS) by the employer.

• Example: Exercise price = ₹50, FMV = ₹150. Taxable perquisite = ₹100 per share.

1. Sale Stage: When employees sell the shares, any profit (FMV at sale minus FMV at exercise) is taxed as capital gains.

• Short-term (held < 12 months): Taxed at slab rates.
• Long-term (held > 12 months): 10% tax on gains above ₹1 lakh (no indexation).

For Companies: Issuing ESOPs isn’t taxable, but compliance with FEMA (for foreign employees) and Companies Act, 2013, is non-negotiable.

Process of Issuing ESOPs

Here’s a step-by-step guide to rolling out ESOPs in India:

1. Draft an ESOP Policy: Define eligibility, vesting period (e.g., 4 years with a 1-year cliff), exercise price, and pool size (typically 7-15% of equity).
2. Board Approval: Get the board’s nod for the ESOP scheme and pool creation.
3. Shareholder Approval: Pass a special resolution (75% majority) under Section 62(1)(b) of the Companies Act, 2013.
4. File with ROC: Submit Form MGT-14 within 30 days of the resolution.
5. Grant Options: Issue grant letters to employees outlining terms.
6. Vesting Period: Employees earn the right to exercise options over time.
7. Exercise Options: Employees buy shares at the set price once vested.
8. Issue Shares: Allot shares and update the company register.

Need help with compliance or structuring? The StartupLab simplifies this for startups daily!

Case Studies: ESOPs in Action

1. Zomato

• Context: Before its 2021 IPO, Zomato used ESOPs to retain talent during cash-tight years.
• Impact: Employees cashed out ₹400 crore post-IPO, proving ESOPs’ wealth-creation potential.
• Takeaway: Strategic ESOPs can turn early hires into millionaires, fueling loyalty.

2.Flipkart

• Context: Flipkart’s ESOP pool was a key perk, especially during its 2018 Walmart acquisition.
• Impact: Over 100 employees became crorepatis as Walmart bought back ESOP shares for $1 billion.
• Takeaway: ESOPs can be a golden handshake for employees and a retention tool for founders.

Practical Tips for Startups

• Set Clear Terms: Avoid ambiguity in vesting or pricing to prevent disputes.
• Educate Employees: Explain ESOP benefits and tax implications upfront.
• Plan Tax Impact: Factor TDS into payroll and guide employees on capital gains.
• Seek Experts: Compliance is complex—partner with pros like The StartupLab for seamless execution.

Conclusion

ESOPs are more than a perk—they’re a strategic lever for startups to attract, retain, and motivate talent while preserving cash. Understanding their taxation and mastering the issuance process can unlock their full potential. From Zomato’s IPO windfall to Flipkart’s acquisition payout, ESOPs prove their worth time and again. Ready to implement ESOPs for your team? Contact The StartupLab—we’ll craft a plan that works for your startup’s growth story!

Follow us and connect with us on Instagram, Facebook, Twitter, and LinkedIn.

Note: If you are a budding entrepreneur and require assistance Register a Company, Startup Funding, Financial Projections, Business Valuation Services, LLP Registration, Compliance Services, Shareholders Agreement, funding formalities, Debt Funding, CFO Services, or other startup-related Legal Services, Contact Us.