ESOP under the Companies Act 2013 for Private Limited Company

ESOP under the Companies Act 2013 has emerged as a powerful employee retention and wealth-creation tool for private limited companies in India. In an increasingly competitive business environment, private companies are actively using Employee Stock Option Plans (ESOPs) to attract skilled professionals, reward long-term commitment, and align employee interests with the company’s growth objectives. The Companies Act, 2013 provides a structured legal framework that enables private limited companies to issue ESOPs in a compliant and transparent manner.

Under ESOP under the Companies Act 2013, eligible employees are granted the right to acquire equity shares of the company at a predetermined price, subject to fulfilment of vesting and exercise conditions. For private limited companies, ESOPs serve as an effective alternative to high cash compensation, especially during early-stage or growth-phase operations. When implemented correctly, ESOPs not only enhance employee motivation but also contribute to sustainable corporate governance.

This blog aims to provide a clear and practical understanding of ESOP under the Companies Act 2013 as applicable to private limited companies, covering legal provisions, eligibility criteria, compliance requirements, and key considerations for successful implementation.

Table of Contents

What is an ESOP under the Companies Act 2013?

An Employee Stock Option Plan (ESOP) is a statutory employee benefit scheme that allows a company to grant its employees the right, but not the obligation, to purchase equity shares of the company at a future date and at a pre-determined price. Under ESOP under the Companies Act 2013, ESOPs are governed by Section 62(1)(b) read with the Companies (Share Capital and Debentures) Rules, 2014, which provide the legal framework for issuance of stock options by a company.

For a private limited company, ESOP under the Companies Act 2013 acts as a strategic tool to reward employee performance, retain key managerial personnel, and create long-term ownership among employees. The stock options granted under an ESOP are subject to conditions such as a minimum vesting period, exercise terms, and shareholder approval through a special resolution.

Unlike direct allotment of shares, ESOPs do not result in immediate ownership. The employee becomes a shareholder only after exercising the vested options and receiving the allotment of shares. Thus, ESOP under the Companies Act 2013 ensures a balance between employee incentives and regulatory compliance while supporting the growth objectives of private limited companies.

Legal Framework of ESOP under the Companies Act 2013

The legal framework for ESOP under the Companies Act 2013 provides the statutory basis and detailed procedural guidance for private limited companies to issue Employee Stock Option Plans in a compliant manner.

Particulars	Legal Provision	Detailed Explanation
Enabling Provision for ESOP	Section 62(1)(b) of the Companies Act, 2013	Section 62(1)(b) of the Companies Act, 2013 expressly permits a company to issue equity shares to its employees under an Employee Stock Option Plan, subject to approval of shareholders by way of a special resolution passed in a general meeting. For a private limited company, this provision forms the statutory authority to grant stock options to eligible employees, ensuring that employee share-based benefits are issued only with the consent of members.
Governing Rules for ESOP	Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014	Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 lays down the comprehensive regulatory framework for ESOP under the Companies Act 2013. These rules prescribe the conditions relating to eligibility of employees, minimum vesting period, pricing of options, disclosure requirements, and maintenance of statutory registers, which a private limited company must comply with while designing and implementing an ESOP scheme.

The above statutory provisions collectively govern ESOP under the Companies Act 2013 and ensure that private limited companies issue employee stock options in a transparent, regulated, and shareholder-approved manner.

Applicability of ESOP under the Companies Act, 2013

ESOP under the Companies Act 2013 applies to all companies issuing shares to employees under Section 62(1)(b).
A private limited company is eligible to issue ESOPs subject to compliance with the Companies Act, 2013 and applicable rules.
ESOP provisions apply only when shares are issued pursuant to a shareholders’ special resolution.
The ESOP scheme must be framed in accordance with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
ESOP provisions apply to equity shares and do not extend to preference shares.
Separate approval is required where ESOPs are granted to employees of holding, subsidiary, or associate companies.
ESOP provisions are applicable to both listed and unlisted companies, with additional requirements for listed entities.
Special relaxations under ESOP provisions apply to eligible start-up private companies for a specified period.

Eligibility of Employees for ESOP under the Companies Act, 2013

Under ESOP under the Companies Act 2013, a private limited company may grant ESOPs to its permanent employees working in India or outside India.
Directors of a private limited company, other than independent directors, are eligible to receive ESOPs.
Employees and directors of the company’s holding, subsidiary, or associate company may be granted ESOPs if the scheme so provides.
A promoter of the company is not eligible to receive ESOPs under normal circumstances.
A director holding more than 10% of the equity shares, directly or indirectly, is not eligible for ESOPs.
Independent directors are expressly prohibited from receiving ESOPs.
The restrictions on promoters and 10% shareholders do not apply to eligible start-up private companies for a prescribed period.

Pricing and Valuation of ESOPs under the Companies Act, 2013

Under ESOP under the Companies Act 2013, a private limited company has the flexibility to determine the exercise price of stock options.
The exercise price may be fixed at a face value, premium, or discount, subject to shareholder approval.
There is no statutory restriction on the pricing of ESOPs for private limited companies under the Companies Act, 2013.
The valuation of shares for ESOP purposes is generally carried out by a registered valuer for fairness and transparency.
Valuation helps in determining the fair market value (FMV) of shares at the time of grant or exercise.
The valuation methodology should be clearly disclosed in the ESOP scheme approved by shareholders.
Proper valuation ensures compliance with accounting, taxation, and disclosure requirements.
Pricing and valuation terms must be consistently applied and documented to avoid future disputes.

Register and Records to be Maintained for ESOP under the Companies Act, 2013

A private limited company must maintain a Register of Employee Stock Options in Form SH-6.
The register should contain details of options granted, vested, exercised, and lapsed.
Entries in the ESOP register must be authenticated by the Company Secretary or authorised person.
The ESOP register must be kept at the registered office of the company or at such other place as approved by the Board.
The register shall be preserved permanently and updated on a timely basis.
Supporting records such as ESOP scheme, grant letters, valuation reports, and board/shareholder resolutions must be properly maintained.

Penalties for Non-Compliance with ESOP Provisions under the Companies Act, 2013

Non-compliance with ESOP under the Companies Act 2013 attracts penalties under Section 450 where no specific punishment is prescribed.
The company may be liable to a monetary penalty for failure to comply with ESOP-related provisions and rules.
Officers in default, including directors and key managerial personnel, may be penalised individually.
Penalties may be imposed for failure to obtain shareholders’ approval through a special resolution.
Non-maintenance or improper maintenance of the ESOP register and records can attract regulatory action.
Incorrect or incomplete disclosures relating to ESOPs in the Board’s Report may result in penalties.
Continued non-compliance may lead to additional fines until the default is rectified.

Conclusion

ESOP under the Companies Act 2013 plays a vital role in driving long-term corporate growth, particularly for private limited companies operating in competitive and resource-constrained environments. By offering ownership-linked incentives, ESOPs help companies attract skilled professionals, retain key talent, and foster a strong sense of commitment and accountability among employees.

To ensure that an ESOP under the Companies Act 2013 is structured correctly and remains fully compliant, professional guidance is essential. Our firm provides end-to-end ESOP advisory services, including drafting of ESOP schemes, shareholder and board documentation, valuation coordination, statutory compliance, and ongoing advisory support for private limited companies. If you are planning to implement or review an ESOP scheme, our team can assist you in designing a legally sound and growth-oriented solution tailored to your business needs.