How to Create an ESOP Pool in India

Learn how to create an Employee Stock Ownership Plan (ESOP) pool in India. Discover the key steps, regulatory requirements, and best practices for successful implementation.
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3 mins read
27-September-2025

An ESOP (Employee Stock Ownership Plan) pool is not just a technical term; it’s a practical way for businesses to share growth with their employees. By reserving a certain percentage of shares, companies allow their team members to benefit directly from the organisation’s success. For startups in particular, this becomes an attractive alternative to offering high salaries while competing for skilled professionals.

What is an ESOP pool?

An ESOP pool is a dedicated portion of a company’s equity set aside for employee stock option plans. In India, it is widely used by businesses especially startups and growth-stage firms, as a way to attract, retain, and reward talent. By offering employees a stake in the company’s future, ESOP pools align individual ambitions with organisational success.

The idea is simple yet powerful: when employees own a part of the business, they think and act like stakeholders, driving performance and loyalty. For companies competing with larger firms, ESOP pools provide an effective edge by offering equity-based rewards in place of heavy cash compensation, ensuring long-term commitment while reducing attrition.

Benefits of establishing an ESOP pool

Here are some of the key benefits of creating an ESOP pool:

  • Attract top talent: Offering equity makes your company more appealing to skilled professionals, especially in competitive markets.

  • Boost retention: Employees are more likely to commit to the organisation when they see long-term ownership rewards.

  • Enhance motivation: Equity-based incentives encourage employees to give their best, knowing they directly benefit from the company’s progress.

  • Improve productivity: When employees feel like stakeholders, they contribute with greater accountability and ownership.

  • Strengthen company culture: ESOPs promote teamwork and alignment between personal goals and organisational objectives.

  • Conserve cash flow: Startups and growing companies can attract and reward employees without straining immediate finances.

By building an ESOP pool thoughtfully, businesses can balance employee expectations, investor requirements, and founder interests, ensuring growth for all stakeholders.

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Steps to create an ESOP pool

The steps to create an ESOP Pool are:

  1. Define the purpose of the ESOP poolStart by determining why the ESOP pool is necessary—whether it's for retention, rewarding performance, or incentivising new hires. Clear goals help shape an effective ESOP structure.
  2. Determine the size of the ESOP poolThe size of the ESOP pool varies, but a typical range is between 10-20% of the total company shares. This decision depends on the company’s stage, hiring plans, and the dilution impact on founders and investors. By carefully assessing the appropriate size, companies can ensure that the ESOP pool meets future hiring and retention needs without excessive dilution.
  3. Decide the vesting periodEstablishing a vesting period encourages employees to stay for the long term. Most companies use a four-year vesting period with a one-year cliff, meaning employees earn equity incrementally but must stay for at least one year to receive any shares. A thoughtfully structured vesting schedule supports retention while also rewarding employees who commit to the company over time.
  4. Legal and compliance requirementsEnsuring compliance with legal and regulatory requirements is essential when creating an ESOP pool. Companies should consult legal and tax experts to structure the ESOP pool according to applicable corporate laws, tax implications, and securities regulations. Proper documentation, shareholder agreements, and board approvals are often necessary steps. Compliance helps prevent future disputes and ensures transparency, protecting both the company and its employees.
  5. Communication strategy for employeesEffective communication around ESOPs is essential for employee buy-in. Companies should explain how the ESOP pool works, the value of stock ownership, and how employees benefit from holding shares. Regular updates on company performance can reinforce the long-term value of ESOPs. Clear communication builds trust, allowing employees to understand their role as shareholders and fostering a sense of ownership within the team.

Impact of ESOP pools on valuation

ESOP pools do dilute founder equity, but they also strengthen the company’s appeal to both employees and investors. A clear, well-structured ESOP plan signals long-term vision and commitment to growth, which can add credibility during funding rounds.

Why do companies create an ESOP pool?

There are several reasons why companies create ESOP pools:

  • Retention: Encourages employees to stay longer by rewarding loyalty with future ownership.

  • Motivation: Employees who own equity often perform with higher accountability.

  • Cash flow management: Startups can compete for top talent without increasing salary expenses.

  • Investor expectations: Investors often expect a well-structured ESOP pool to support hiring plans.

ESOP pool structure in India

The ESOP pool in India is designed with clear guidelines on size, distribution, and vesting to ensure fairness and transparency.

  • Typical pool size: Indian companies, especially startups, generally allocate 10%–20% of total equity to the ESOP pool, depending on growth stage and investor expectations.
  • Allocation logic: Shares are distributed based on employee roles, seniority, and contribution to business growth, ensuring fairness and alignment with organisational goals.
  • Vesting schedules: ESOPs in India usually follow a vesting period of 3–5 years with a one-year cliff, promoting long-term employee commitment.

Common mistakes to avoid when creating an ESOP pool

While ESOP pools can be powerful, some common missteps can reduce their effectiveness. Here is what to avoid:

  1. Setting an unrealistic vesting schedule that fails to meet retention goals.
  2. Offering too many shares, resulting in excessive dilution.
  3. Not seeking expert legal and tax guidance on structuring the ESOP.
  4. Insufficient communication, leading to misunderstandings about ESOP benefits.
  5. Failing to update or replenish the ESOP pool as the company scales.

Conclusion

An ESOP pool is more than a hiring tool, it’s a long-term strategy to align employee goals with the company’s vision. For Indian startups and growing firms, learning how to create an ESOP pool in India and supporting it with financing options can transform equity into a practical, rewarding benefit for employees.

Frequently asked questions

What is the minimum size for an ESOP pool in India?
Typically, Indian startups allocate 10-20% of total equity to create an ESOP pool, depending on company goals and resources.

How does an ESOP pool impact employee retention?
ESOP pools enhance employee retention by giving staff an ownership stake, incentivising long-term commitment to the company's growth.

What are the tax implications of ESOPs for employees?
ESOPs are taxed when shares are exercised and sold, impacting income and capital gains tax liabilities

Can startups create an ESOP pool?
Yes, startups can create ESOP pools to attract and retain talent, using them as strategic tools for growth and employee alignment.

How much equity should be allocated to an ESOP pool?

Typically, Indian companies allocate 10%–20% of their total equity to an ESOP pool. The exact size depends on company stage, investor expectations, and talent needs.

What are the legal steps to set up an ESOP pool in India?

Setting up an ESOP pool involves board approval, shareholder resolution, drafting an ESOP scheme, and complying with Companies Act, 2013 and SEBI regulations for listed companies.

How does ESOP dilution affect existing shareholders?

ESOP issuance dilutes existing shareholders’ ownership as new shares are allocated to employees. While reducing individual stake, it can increase company value by retaining talent and boosting performance.

Who is eligible to receive ESOPs in India?

In India, ESOPs can be granted to permanent employees, directors, and officers of the company or subsidiaries. Promoters and independent directors are generally ineligible under SEBI guidelines.

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