Time to strategize Stock Options for Employees of Unlisted Companies

December 07,2017
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Homi Mistry (Partner, Deloitte Haskins and Sells LLP)
Mousami Nagarsenkar (Director)
Jimish Vakharia (Manager)







Employee compensation is one of the key considerations for an organisation. A good blend of cash and non-cash rewards can attract and retain strategic talent, which will help increase the value of the organisation (i.e. share price).

This increase in the value of the organisation can be shared with the employees by offering them equity. Employers, therefore, adopt employee stock rewards to promote employee participation in equity. Employee stock options play a vital role in formulating the compensation strategy, especially for senior level employees in the organisation.

Drafting an appropriate Employee Stock Option Scheme (ESOS) tailored to the specific circumstances and needs of the organisation can aid in achieving the organisation’s objectives of attracting, motivating and retaining the best talent in the industry.

Implementing ESOS has its own Pros and Cons which are summarized in brief below: 

Pros Cons

1. Attract and retain the best talent

1. Dilution of promoter/investor holding

2. Wealth creation for employees in proportion to organisational growth

2. If options are underwater (due to market fluctuations and policy changes, etc), the objective of motivation and growth will not be achieved

3. Motivation and sense of ownership for employees

3. Additional compliance / administrative requirements so as to adhere to applicable rules and regulations

4. No cash outflow for employer

4. Could impact financials of the company
5. Long term sustainable growth for company with key talent retained 


Below is a summary of the provisions of the Act read with Rules (as amended from time to time), applicable to ESOS for unlisted companies (public or private company):ESOS can be implemented by both listed as well as unlisted companies. Listed companies also need to comply with SEBI[1] regulations. For unlisted companies, in the erstwhile Companies Act, 1956 there were no prescribed rules/regulations for implementing ESOS. However, the Companies Act, 2013 (‘Act’), which is currently in effect, prescribes rules governing ESOS for unlisted companies i.e. Companies (Share Capital and Debentures) Rules, 2014 (‘Rules’) which need to be complied with.

Particulars  Summary
Effective dateThe rules have come into effect from 1 April 2014.
Employee eligibility

As per the provisions of the Act[2], employee stock option means options given to the directors, officers or employees of a company or its holding or subsidiary company(s), to purchase or subscribe for shares of the company at a future date at a pre-determined price

As per Rules[3] eligible employees are :

- Permanent employees of the company

- Director of the company (whether a whole time director or not but excluding an independent director)

- Employee of a subsidiary (in or outside India) or holding company[4]

As per Rules, Employees not eligible include:

- Employee who is a Promoter or a person belonging to the promoter group; or

- Director who, either himself or through a relative, directly or indirectly holds more than ten percent of the outstanding equity shares of the company.

As per a subsequent notification[5], in case of a start-up company[6], even such persons (ie promoter, director as mentioned above), are eligible for ESOS upto 5 years from the date of its incorporation or registration of the start-up.

Key compliance requirements

- ESOS should be approved by shareholders by passing a special resolution

- Necessary disclosures (like number of stock options granted, vested, exercise price/formula etc) to be made in explanatory statement to the notice for passing shareholders resolution

- Necessary disclosures to be made in Director’s Report (like options granted, vested, lapsed, exercise price etc)

- Maintain a register of ESOS in Form SH 6

-  Approval of shareholders by way of separate resolution is required for:

  • Granting options to employees of subsidiary or holding company; or
  • Granting of options to identified employee, equal to or exceeding 1 % of the issued capital (excluding outstanding warrants and conversions) during any one year

- In case of issue of stock options to non-residents, it is important to take into consideration the foreign exchange regulations and ensure that sectoral caps prescribed, if any, are complied with.

Key Conditions


- Minimum vesting period to be 1 year (i.e. period between grant and vesting of the stock options)

- Freedom to determine the exercise price in conformity with the applicable accounting policies

- Freedom to specify the lock in period post exercise of options

- Employee shall not have right to receive dividend or to vote in any manner or enjoy the benefits of a shareholder, till shares are issued on exercise of options

- The options granted are not transferable and cannot be pledged, hypothecated, mortgaged, or otherwise encumbered in any other manner

- In case of death / permanent incapacitation while in employment all granted options shall vest in the legal heirs / nominee of the deceased employee or the employee, as the case may be

- Company can provide financial assistance to its own employees for purchase / subscription of share of company or holding company either directly or through a Trust (subject to specified conditions / rules[7])


Non-compliance with the Rules entails penalty and hence, it may be advisable to seek professional assistance in drafting and implementation of ESOS.Before the introduction of the Rules, unlisted companies were free to implement ESOS as desired by them. With the introduction of the Rules, all unlisted companies including private companies need to adhere to the conditions and limits prescribed in the Rules.

[1] Securities and Exchange Board of India

[2] Section 2(37) of the Act

[3] Rule 12(2) of the Rules

[4] Employees of Associate companies were also eligible, however vide notification GSR 210 ( E) dated 18 March 2015, the same was deleted

[5] GSR 704 ( E) dated 19 July 2016

[6] As defined in the Notification GSR 180 (E ) of the Government of India Ministry of Commerce & Industry Department of Industrial Policy & Promotion dated 17 February, 2016

[7] Rule 16 of the Rules