ESOP Mistakes Indian Startups Make (and How to Avoid Them)

The most common ESOP mistakes Indian startups make are legal and procedural. Founders promise options before a scheme exists, write a vesting schedule that breaks the one-year rule, miss MCA filings, or work out tax on the wrong value. Others damage trust instead: vague rules for people who leave, short exercise windows, and grants explained as a headline number. Each one is easier to prevent than to fix. Here are twelve common ESOP mistakes, and how to avoid each.

Mistakes when setting up the scheme

1. Promising options before the scheme is approved

An offer letter sometimes says "you will get 5,000 ESOPs" before the company has an ESOP scheme. An unlisted company can grant options only under a scheme its shareholders have approved. That is the rule in Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Until then, there is nothing to grant from, and the promise sits outside the law.

Rule 12 asks for a special resolution. Advisory firm Treelife notes that a private company with up-to-date filings can use a 2015 exemption to pass an ordinary resolution instead. It still recommends a special resolution in every case.

How to avoid it: Approve the scheme early, before you start making offers. Word offer letters as "a grant of options, subject to the company's ESOP scheme and board approval". Then grant formally through the board or its ESOP committee, and send a grant letter.

2. Template schemes and grant letters that do not match

A scheme copied from another company often misses terms that Rule 12 requires the shareholders' notice to explain, including:

• the total number of options and who is eligible
• the vesting requirements and the maximum vesting period
• the exercise price, or the formula for it
• the exercise period, and the time a leaver gets to exercise
• the conditions under which options lapse
• the maximum number of options per employee

The second half of this mistake is the grant letter. Treelife advises that a grant letter should not give one employee terms that differ from the scheme without fresh approval. A letter that promises a longer exit window or faster vesting than the scheme allows creates a promise the company may not be able to keep.

How to avoid it: Draft the scheme from the Rule 12 list, for your business. Use one grant letter template that refers to the scheme and states the number of options, the exercise price in rupees, the vesting schedule and the exit window.

3. Granting options to people who are not eligible

Rule 12 defines who counts as an employee for ESOPs. It includes permanent employees in India or abroad, directors other than independent directors, and employees of a subsidiary or holding company. It leaves out:

• promoters and members of the promoter group
• directors who hold more than 10% of the equity, directly or indirectly
• independent directors

A DPIIT-recognised startup is exempt from the promoter and 10% exclusions for up to 10 years from incorporation. Consultants and advisers do not fit the definition at all, so they need a different reward, such as cash or phantom stock.

Two kinds of grant also need their own shareholder resolution:

• grants to employees of a subsidiary or holding company
• grants to one person of 1% or more of the issued capital in a single year

How to avoid it: Check eligibility before every grant, not only when the scheme is approved. Founders of older startups should check the 10-year window before they plan their own grants.

4. No room in the pool or the authorised capital

An ESOP pool sets how many options you can grant. Authorised capital, the maximum share capital in your memorandum, sets how many shares you can issue when employees exercise. The two are easy to confuse, but you need room in both.

If authorised capital runs short, the company needs shareholder approval to increase it, and must file Form SH-7 within 30 days of the resolution. Doing that in a hurry, while an employee waits to exercise, is avoidable.

How to avoid it: Size the pool to your hiring plan for the next 18 to 24 months. Indian CFO advisory firm CFOmatrix describes a pool of about 10% as the most common starting point. Check authorised capital at the same time.

Mistakes when granting options

5. A cliff shorter than one year

Rule 12 requires at least one year between the grant of an option and its vesting. SEBI's rules for listed companies set the same minimum. A schedule that vests anything earlier, such as monthly vesting from the first month, breaks the rule.

The common slip is counting from the joining date. As Treelife explains, the year runs from the grant date. If someone joins in April and the board grants their options in July, nothing can vest before the following July.

How to avoid it: Make the first vesting date at least 12 months after the grant date. If an offer promised credit from the joining date, add a catch-up to a later tranche instead of vesting early. The only exceptions in Rule 12 are death and permanent incapacity, when options vest at once.

6. An exercise price below face value

A company is free to set the exercise price, but Section 53 of the Companies Act bars issuing shares at a discount. So the exercise price cannot be lower than the share's face value, often ₹1 or ₹10.

How to avoid it: Set the price at face value or above, and write it in the grant letter as a fixed rupee amount. If you use a formula, check that it can never produce a number below face value.

Tax and accounting mistakes

7. Taxing on the wrong value

When an employee exercises, the difference between the fair market value of the share and the exercise price is taxed as salary, as a perquisite. The employer must deduct TDS on it.

For an unlisted company, the fair market value must come from a valuation by a SEBI-registered Category I merchant banker. Two things go wrong:

• Using the wrong number. The price investors paid in the last round, or a valuation done for issuing shares, is not the figure the perquisite rules ask for.
• Using an old report. Under the earlier tax rules, the valuation could be dated no more than 180 days before the exercise.

The numbers can differ widely. In 2019, Byju's valued its shares at ₹50,736 for ESOP purposes, while investors in its July 2019 round paid ₹1,14,910 per share.

How to avoid it: Get a merchant banker valuation dated close to each exercise window, and run exercises through payroll so TDS is deducted on time.

8. Assuming every startup can defer ESOP tax

Eligible startups can let employees put off paying tax on exercise. The employer then deducts it within 14 days of the earliest of three dates:

• 60 months from the end of the tax year in which the shares were allotted
• the date the employee sells the shares
• the date the employee leaves

The catch is eligibility. A startup needs DPIIT recognition and a tax-exemption certificate from the Inter-Ministerial Board. About 3,700 startups had the certificate by May 2025, against more than 1.6 lakh recognised startups. A founder who tells employees "there is no tax until you sell" without that certificate sets them up for a surprise bill.

How to avoid it: Check whether your company has the certificate before you describe the tax to employees. If it does not, say plainly that tax is due on exercise.

9. Leaving the ESOP cost out of the accounts

ESOPs cost no cash when granted, but they are an employee expense in the accounts. Ind AS 102 applies to listed companies, unlisted companies with a net worth of ₹250 crore or more, and their group companies. They spread the fair value of each option at the grant date over the vesting period.

Other companies follow the ICAI Guidance Note on share-based payments. It recommends fair value but also allows the intrinsic value method, which can show little or no cost. Treelife warns that ESOP accounting errors tend to surface as restated comparatives, auditor queries or a delayed investor closing.

How to avoid it: Value each grant on its grant date and book the expense from the start, even if you are not yet on Ind AS. A later investor or acquirer may restate it anyway.

Filing and record-keeping mistakes

10. Missing filings and registers

ESOPs create a steady flow of paperwork. These are the filings and records to track:

• Form MGT-14 within 30 days of the shareholders' special resolution approving the scheme.
• Form PAS-3, the return of allotment, within 30 days of each allotment of shares when employees exercise.
• The register of employee stock options, Form SH-6, kept up to date with every grant, exercise and lapse.
• Board's report disclosures each year: options granted, vested, exercised and lapsed, the exercise price, money realised and employee-wise details for key people.
• Form ESOP, filed through the company's bank within 30 days of granting options to an employee who lives outside India. FC-GPR follows within 30 days of allotting them shares.
• Demat shares. Private companies that are not small companies must issue securities only in dematerialised form under Rule 9B, so employees need a demat account before they exercise.

Late filings carry real penalties. For MGT-14, Section 117(2) sets ₹10,000 plus ₹100 for each day of delay, up to ₹2 lakh for the company and ₹50,000 for each officer in default. In March 2026, the Registrar of Companies in Chennai fined Garuda Aerospace and two of its directors ₹52,700 each for filing two MGT-14 forms about five months late. For PAS-3, the penalty is ₹1,000 a day, up to ₹1 lakh, on top of additional filing fees.

How to avoid it: Keep one compliance calendar for the scheme and give each filing an owner, usually the company secretary.

Mistakes when people leave

11. Vague leaver rules and short exercise windows

Rule 12 sets the baseline. When someone resigns or their job ends, unvested options lapse, and vested options can be exercised within the period the scheme sets. Everything else is up to the scheme, which is where problems start:

• No clear good and bad leaver rules. If the scheme does not say who keeps vested options and who loses them, every exit becomes a negotiation.
• Windows too short to use. Treelife describes 30 to 90 days as common. Exercising means paying the exercise price and the tax at once, for shares that may not be sellable. A short window can force people to walk away from vested options.
• Forfeiture for joining a competitor. Treelife warns that cancelling vested options for this may not hold up, because Section 27 of the Indian Contract Act limits restraints on trade.

Some companies are generous. Meesho's scheme gives up to 10 years from the last working day. Swiggy's 2021 plan gives former employees 36 months to exercise once the company is listed.

Changing the window later is risky too. A scheme can be varied only by special resolution, and only if the change does not hurt existing option holders. In December 2025, Unacademy told former employees they would have 30 days to exercise, instead of up to 10 years. After public criticism, it put the change on hold in January 2026, saying it would revisit the policy "if required".

How to avoid it: Define good and bad leavers in the scheme, keep bad leaver rules for misconduct, and set a window people can realistically use. If you must change terms, talk to option holders before you put it to shareholders.

Explaining ESOPs to your team

12. Explaining ESOPs badly

This mistake is easy to make without noticing. A grant is often described as "₹40 lakh of ESOPs" with everything left out that decides what it is really worth:

• the grant as a percentage of fully diluted shares
• the exercise price and the vesting schedule
• the tax due on exercise
• how dilution and investors' liquidation preferences could shrink the payout
• when, if ever, the shares can be sold

When the real value arrives lower than the headline, employees feel misled, even if nothing was untrue.

How to avoid it: Show cash pay and ESOPs separately in offers. Explain grants as a percentage of the company, an exercise price and a schedule. Share the fully diluted share count, and update employees after each funding round.

This article is general information, not legal, tax or accounting advice. Speak to a company secretary, chartered accountant or lawyer before you set up or change an ESOP scheme.