Adopt the scheme before granting anything. Options granted under a scheme that has not been approved by the members, or granted to a person outside the definition of employee, cannot be validated afterwards, and both defects are found in almost every first institutional diligence.
Employee Stock Option Scheme
[COMPANY NAME] Employee Stock Option Scheme [YEAR]
Adopt the scheme before granting anything. Options granted under a scheme that has not been approved by the members, or granted to a person outside the definition of employee, cannot be validated afterwards, and both defects are found in almost every first institutional diligence.
| Item | Detail |
|---|---|
| Company | [COMPANY NAME], CIN [CIN] |
| Name of the scheme | [COMPANY NAME] Employee Stock Option Scheme [YEAR] |
| Board approval | [DATE] |
| Members’ approval | [DATE], by [special resolution / ordinary resolution, relying on the relaxation available to private companies] |
| Effective date | [DATE] |
| Total options authorised | [NUMBER], being [PERCENTAGE] per cent of the share capital on a fully diluted basis |
| Administered by | The Board [, acting through the Compensation Committee] |
| Scheme version | [NUMBER] |
1. Purpose and Definitions
1.1The purpose of this Scheme is to attract, retain, motivate and reward employees by giving them an opportunity to participate in the growth of the Company and to align their interests with those of its shareholders.
1.2In this Scheme:
"Board" means the board of directors of the Company, and where a Compensation Committee has been constituted, includes that Committee acting within its delegated authority.
"Employee" means (a) a permanent employee of the Company who has been working in India or outside India; (b) a director of the Company, whether a whole-time director or not, but excluding an independent director; and (c) an employee or a director as described in (a) or (b) of a subsidiary, in India or outside India, or of a holding company or an associate company of the Company; but does not include an employee who is a promoter or belongs to the promoter group, or a director who, directly or indirectly, holds more than the prescribed percentage of the outstanding equity shares of the Company, [save that, the Company being a startup recognised by the Department for Promotion of Industry and Internal Trade, those exclusions do not apply for the period permitted from the date of its incorporation].
"Exercise" means an Employee making an application to the Company for the issue of Shares against Options vested in that Employee, in accordance with Clause 6.
"Exercise Period" means the period within which a Vested Option may be exercised, as set out in Clause 6.2 and in the Grant Letter.
"Exercise Price" means the price payable by an Employee for exercising an Option, determined under Clause 5.
"Grant" means the issue of Options to an Employee under this Scheme, and "Grant Date" and "Grant Letter" shall be construed accordingly.
8 more pages in the Word file
Preview of the first page. Highlighted fields are the ones you fill in — they appear the same way in Word. Scroll the preview to read on; the full document runs to 9 pages.
These notes accompany the template and explain the drafting choices, the compliance points and the mistakes most often made with this document. They appear as a final page in the Word file, intended to be deleted before the document is executed.
Options granted before the members have approved the scheme are not validly granted, and the defect cannot be cured retrospectively without re-granting on current terms, which changes the economics for the employee. Companies that promise options in an offer letter and adopt a scheme two years later create exactly this problem. Adopt the scheme, then grant.
The definition of Employee is prescribed and excludes promoters, members of the promoter group, independent directors, and directors holding more than the prescribed percentage of equity. A recognised startup is relieved from the promoter and shareholding exclusions for a period from incorporation, which is why many founders can hold options in an early-stage company and cannot in a mature one. Confirm the recognition is subsisting, and confirm the current period of the relief, before granting to anyone in those categories.
A person engaged as a consultant, an adviser, or through a service company is not an Employee. Granting to them under this scheme is a defect. Where the Company wishes to give equity to an adviser, use a different instrument — typically a direct share issue on restricted terms — and take advice, because it engages different provisions.
There must be a minimum period between grant and vesting, which may not be less than one year. A grant purporting to vest immediately, or to vest on a date within a year of grant, is void as to that tranche. Acceleration on death or permanent incapacity is expressly permitted; acceleration on other events should be checked before it is relied on.
A face-value exercise price gives the employee the largest possible gain and the largest possible perquisite charge on exercise. A fair-value exercise price gives a smaller charge and a smaller gain. Neither is wrong, but employees are frequently not told that exercising creates a tax liability payable in cash at a time when the shares cannot be sold. Explain it in the grant letter, not at exercise.
The perquisite is taxed at exercise, on the difference between fair market value and the exercise price, whether or not the employee can sell anything. In an unlisted company that means a real cash cost with no liquidity. The practical answers are to keep the exercise price low but the window long, to permit exercise only at a liquidity event, or to facilitate a cashless exercise as Clause 8.4 contemplates. Decide which before employees start leaving.
A deferral of the obligation to deduct tax on the perquisite is available in respect of options issued by eligible startups, running until the earliest of a prescribed period, the sale of the shares, or the employee ceasing to be employed. Eligibility is narrower than recognition as a startup for other purposes. Confirm eligibility and the current mechanics before relying on it, and note that the deferral moves the liability, it does not remove it.
A short exercise window after resignation — thirty or ninety days — combined with a cash tax cost at exercise means that in practice a departing employee forfeits vested options. That may be the intended commercial position, but it should be a decision, not an accident. A longer window for good leavers is increasingly common and costs the company little.
Annexure B exists because the single most common ESOP finding in diligence is that more options have been granted than were ever authorised, usually because lapsed options were re-granted without being tracked, or because grants were made from a spreadsheet that nobody reconciled to the members’ resolution. Reconcile every quarter and place the reconciliation before the Board.
A grant recorded only in a board resolution or a spreadsheet, with no signed acknowledgement from the employee, is difficult to enforce and difficult to prove. Clause 4.2 makes the grant conditional on a signed acknowledgement. Chase them; unsigned grant letters accumulate.
An employee who exercises becomes a shareholder, with inspection rights, and a party who must be dragged along on an exit. Clause 10.2 makes execution of a deed of adherence a condition of allotment. Without it, a company can find itself with a minority shareholder who is not bound by the transfer restrictions in the investor documents.
The register of options must be maintained in the prescribed form, and the scheme must be disclosed in the Board’s report. Both are routinely omitted by companies that otherwise administer their scheme carefully.
Reflects Indian law current as of {{DATE OF USE}}. The definition of employee, the startup relaxations and their duration, the minimum vesting period, the prescribed register and the tax deferral mechanics all change — have the scheme reviewed by a company secretary and a tax adviser before adoption, and again before any change of control.
This is a ready-to-use template provided for convenience. Laws and requirements change, and every situation is different — please have it reviewed by a qualified professional (a lawyer, company secretary, or chartered accountant as relevant) before you rely on it.