ESOPs in India: A Practical Guide for Growing Companies

ESOPs in India: A Practical Guide for Growing Companies

In growing organisations, the most powerful incentive is not compensation alone, but participation. When employees see themselves as contributors to long-term value creation rather than short-term outcomes, the way they think, decide and stay with the organisation changes fundamentally. In India’s evolving startup and growth ecosystem, Employee Stock Ownership Plans (ESOPs) have moved far beyond being retention tools. They are now strategic instruments that influence culture, governance and wealth creation.

As India continues to see a steady rise in DPIIT-registered startups, professionally managed family businesses and listed companies expanding through talent-led growth, ESOP adoption has accelerated across sectors. Founders and boards are increasingly recognising that sustainable scale is built not only on capital and market opportunity, but on ownership thinking embedded across leadership and teams. When structured thoughtfully, ESOPs help convert employees into long-term partners in the growth journey.

This guide is written for Indian founders, promoters, boards and leadership teams. It focuses on how ESOPs work in the Indian context, the regulatory framework that governs them, and the strategic choices that shape their long-term impact.

Indian companies operate in an environment defined by rapid growth, talent competition and long value-creation cycles. Traditional compensation structures, while essential, often struggle to fully reward the risk employees take when they join early, scale operations or stay through periods of uncertainty.

ESOPs address this gap by creating a deeper alignment between individual contribution and enterprise value. They enable companies to reward commitment without placing immediate pressure on cash flows, while also fostering a mindset where employees think like owners rather than function-specific contributors. For businesses building for the long term, this alignment can be transformative.

Employee Stock Ownership Plans allow eligible employees to acquire shares or share-linked benefits in the company, usually after completing a defined period of service or meeting specified conditions. At their core, ESOPs represent a promise: that those who help build the company will participate in the value it creates.

Unlike cash incentives, equity participation links reward to the organisation’s long-term performance. This makes ESOPs particularly relevant in India, where many businesses prioritise sustainable growth over short-term profitability.

While structures vary, most ESOP frameworks include four foundational elements:

The way these elements are designed and communicated has a significant impact on how employees perceive the value of their equity.

Understanding India’s regulatory landscape is essential for compliant and effective ESOP implementation. The framework seeks to balance flexibility for companies with transparency and protection for stakeholders.

Companies Act, 2013 governs the issuance and allotment of shares to employees under Section 62(1)(b), read with the Companies (Share Capital and Debentures) Rules, 2014. These provisions apply primarily to unlisted companies and prescribe approval processes, disclosures and conditions for ESOP issuance.

SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 apply to listed companies. These regulations set out detailed requirements relating to eligibility, vesting, lock-in, disclosures, shareholder approvals and administration of employee benefit schemes.

Income Tax Act, 1961 determines the tax treatment of ESOPs, including perquisite taxation at exercise and capital gains taxation at sale. Special deferral benefits are available to eligible startups, subject to prescribed conditions.

FEMA and FDI Regulations become relevant when ESOPs are issued to non-resident employees or employees based outside India. Such issuances must comply with the Foreign Exchange Management Act and the Non-Debt Instruments Rules administered by the Reserve Bank of India.

Recent regulatory amendments have made ESOPs more practical for startups and growth companies, including relaxed timelines and improved tax deferral mechanisms. However, compliance remains documentation-intensive and requires careful planning.

This is the core distinction Indian business leaders must understand when designing ESOPs.

For startups, private companies and closely held businesses, ESOPs are primarily a long-term value participation tool rather than an immediate wealth instrument. Employees typically realise value only upon a liquidity event such as a strategic sale, IPO or structured buy-back.

Key characteristics include:

In unlisted companies, ESOPs are as much about signalling trust and intent as they are about financial upside. Poorly explained plans can lead to frustration, while well-communicated ones create deep loyalty.

In listed entities, ESOPs function differently due to the presence of an active market for shares and stricter regulatory oversight.

Key characteristics include:

For listed companies, ESOPs are not just employee benefits but also governance tools that align management incentives with shareholder interests.

Taxation is often the most misunderstood aspect of ESOPs in India. While there is no tax at the time of grant, employees may face tax liabilities before they actually realise cash benefits.

Typically, ESOP taxation operates at two stages:

For eligible startups, the government has introduced deferral mechanisms that allow employees to postpone perquisite tax until a later triggering event. However, these benefits apply only under specific conditions.

From an advisory perspective, the key risk lies not in taxation itself, but in inadequate communication. Employees who do not understand the timing and quantum of tax exposure may perceive ESOPs as burdensome rather than rewarding.

An ESOP’s effectiveness depends less on legal drafting and more on how it is embedded into the organisation.

Indian companies that derive real value from ESOPs focus on:

When employees understand how their daily work connects to long-term enterprise value, ESOPs become a behavioural lever rather than a financial promise.

Infosys was among the earliest Indian companies to institutionalise employee ownership at scale. Its ESOP programmes helped align senior leadership with shareholder interests while reinforcing a culture of long-term value creation. Over the years, equity-linked compensation became an integral part of Infosys’ governance framework, supporting professional management and continuity beyond founders.

Flipkart’s ESOP journey is widely cited as a landmark in Indian startup history. Through structured buy-backs and liquidity events linked to strategic investments, Flipkart enabled large-scale wealth creation for employees across levels. The ESOP programme played a critical role in retention during high-growth and high-pressure phases.

Freshworks’ public listing demonstrated how ESOPs can translate into tangible wealth for employees when startups mature into listed companies. A significant portion of its workforce participated in equity ownership, reinforcing the idea that ESOPs, when sustained over time, can deliver meaningful outcomes.

At Hedge-Square, we advise Indian founders, promoters and boards on designing ESOP frameworks that are legally robust, tax-aware and strategically aligned. Our approach goes beyond compliance to focus on intent, clarity and long-term sustainability.

Our ESOP advisory services include:

A well-designed ESOP is not a checkbox exercise. It is a strategic decision that shapes culture, retention and long-term value creation. With the right advisory approach, ESOPs can become one of the most powerful tools in an Indian company’s growth journey.