Employee Stock Ownership Plans (ESOPs) let startups attract and retain talent by giving employees a stake in the company's future. Understanding grant, vesting and exercise — and the tax — is essential for both founders and employees.
This guide explains how ESOPs work.
What is ESOP (Employee Stock Options)?
An ESOP grants an employee the right to buy company shares at a fixed price after a vesting period. Vesting spreads over years to encourage retention; the employee exercises the option to become a shareholder.
In India, ESOPs are taxed twice — as a perquisite at exercise and as capital gains at sale.
| Grant | Options awarded at a set exercise price |
|---|---|
| Vesting | Options become exercisable over time |
| Exercise | Employee buys shares (taxed as perquisite) |
| Sale | Capital gains tax on eventual sale |
Frequently asked questions
When are ESOPs taxed?
At exercise (as a salary perquisite on the difference between market value and exercise price) and again as capital gains when the shares are sold.
Why do startups offer ESOPs?
To attract talent they may not be able to pay top salaries, by sharing in the company's future upside.