Eligibility And Procedure For Issuance Of ESOPs By Unlisted Private Limited Companies

This article is prepared to provide a general guide to the subject matter.

The Companies Act, 2013 (the “Act”) and Rule 12 of the (Share Capital and Debentures) Rules, 2014 (the “Rules”) prescribes the provisions for the issue of Employee’s Stock Options by unlisted private limited companies.

The Companies Act, 2013

As per Section 62 (1) (b) of the Act, an unlisted private limited company can issue further shares to employees under a scheme of Employees’ Stock Option (“ESOPs“), pursuant to a special resolution. The Company has to follow the procedure prescribed under the Rules.

Employees’ stock option” is defined under Section 2(37) of the Act as:

option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price”.

Rule 12 of the (Share Capital and DebenturesRules, 2014

Under the said Rules, ESOPs can be issued only to the “employees” of an unlisted private limited company.

Rule 12(1) defines “Employee” as:

a) a permanent employee of the company who has been working in India or outside India; or

b) a director of the company, whether a whole time director or not but excluding an independent director; or

c) an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company or of an associate company.

As per Rule 12(c), the following are not included in the definition of an Employee and therefore ESOPs cannot be issued to the following:

  1. an employee who is a promoter or a person belonging to the promoter group; or
  2. a director who either himself or through his relative or through anybody corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.

However, the above conditions provided in Rule 12(c) are not applicable to a start-up company for a period of 5 years from the date of its incorporation or registration.

Once a private limited company identifies employees who are eligible to avail benefits under the ESOP Scheme, the company is required to comply with the following requirements:

  1. The Employees Stock Option Scheme needs to be approved by the shareholders of the company by passing a special resolution.
  2. The company is required to make the following disclosures, in the explanatory statement annexed to the notice for passing of the resolution:
  1. The total number of stock options to be granted;
  2. identification of classes of employees entitled to participate in the Employees Stock Option Scheme;
  3. the appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;
  4. the requirements of vesting and period of vesting;
  5. the maximum period within which the options shall be vested;
  6. the exercise price or the formula for arriving at the same;
  7. the exercise period and process of exercise;
  8. the lock-in period, if any;
  9. the maximum number of options to be granted per employee and in aggregate;
  10. the method which the company shall use to value its options;
  11. the conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct;
  12. the specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee; and a statement to the effect that the company shall comply with the applicable accounting standards.
  1. The companies granting option to their employees pursuant to ESOPs Scheme can determine the exercise price in conformity with the applicable accounting policies, if any.
  2. The approval of shareholders by way of separate resolution needs to be obtained by the company in case of:

a) grant of option to employees of subsidiary or holding company; or

b) grant of option to identified employees, during any 1 year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.

  1. The company may by special resolution, vary the terms of ESOPs Scheme not yet exercised by the employees provided such variation is not prejudicial to the interests of the option holders. The notice for passing special resolution for variation of terms of ESOP Scheme shall disclose full of the variation, the rationale therefore, and the details of the employees who are beneficiaries of such variation.
  2. (a) Minimum period of 1 year between the grant of options and vesting of option.

(b) The company can specify the lock-in period for the shares issued pursuant to exercise of option.

(c) The Employees shall not have right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of option granted to them, till shares are issued on exercise of option.

  1. The amount, if any, payable by the employees, at the time of grant of option-

a) may be forfeited by the company if the option is not exercised by the employees within the exercise period; or

b) the amount may be refunded to the employees if the options are not vested due to non-fulfilment of conditions relating to vesting of option as per the ESOP Scheme.

  1. (a) The option granted to employees is not transferable to any other person.

(b) The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

(c) Subject to clause (d), no person other than the employees to whom the option is granted shall be entitled to exercise the option.

(d) In the event of the death of employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

(e) In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.

(f) In the event of resignation or termination of employment, all options not vested in the employee as on that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the board of directors of the company.

  1. The board of directors of the company, shall, inter alia, disclose in the Directors’ Report for the year the following details such as (i) the options granted, vested, exercised and lapsed, (ii) the total number of shares arising as a result of exercise of options (iii) the exercise price, (iv) variation of terms of options, (v) money realized by exercise of options, (vi) total number of options in force, and (vii) employee wise details of options granted to the key managerial personnel, any other employees and identified employees.


In addition to the above requirements, the company is required to comply with the following compliances as per Rule 12 (10) of the Rules:

(a) Maintain a Register of Employee Stock Options in Form No. SH.6 and shall enter the particulars of option granted under Section 62 (1) (b) of the Act.

(b) The Register of Employee Stock Options shall be maintained at the registered office of the company or such other place as the board of directors of the company may decide.

(c) The entries in the register shall be authenticated by the company secretary of the company or by any other person authorized by the board of directors for this purpose.

Article by Mini Raman and Angelina Talukdar, 1st published on Mondaq