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
04-September-2025

An ESOP (Employee Stock Ownership Plan) pool is a reserve of shares set aside by a company to grant ownership stakes to employees, enabling them to earn equity in the organisation. The ESOP pool serves as a critical retention tool, aligning employee interests with company growth and success. By establishing an ESOP pool, companies can reward employees for their contributions while incentivising long-term commitment. Typically, ESOP pools are created by startups and other companies aiming to attract talent in competitive markets, allowing employees to benefit financially as the company grows in value.

What is an ESOP pool?

An ESOP pool is a portion of a company’s equity reserved specifically for employee stock option plans. In India, businesses create these pools to attract, retain, and reward talent by offering employees ownership in the company’s growth. The purpose is to align employee interests with organisational success, foster long-term commitment, and reduce attrition. For startups and growing enterprises, ESOP pools also serve as a powerful tool to compete with larger firms by offering equity-based incentives.

Benefits of establishing an ESOP pool

Creating an ESOP pool offers several advantages, particularly for startups. It helps attract and retain skilled employees by providing them with equity, which acts as a powerful motivator. ESOP pools foster loyalty, as employees gain a vested interest in the company’s success. Additionally, ESOPs can increase productivity, as employees are more likely to invest extra effort when they are stakeholders. They also promote alignment between the company’s objectives and employees' financial goals, thereby improving morale and encouraging teamwork. For founders, ESOPs offer a way to attract top talent without significantly impacting cash flow.

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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.

Why do companies create an ESOP pool?

Companies create ESOP pools to balance growth, attract skilled talent, and build long-term commitment by aligning employee interests with organisational success.

  • Talent retention: ESOP pools encourage employees to stay longer with the company by offering future ownership benefits, reducing attrition and ensuring organisational stability.
  • Employee motivation: Equity-based rewards make employees feel invested in the company’s success, driving higher productivity, accountability, and commitment toward achieving business goals.
  • Startup funding implications: Investors often expect startups to create ESOP pools, ensuring there’s reserved equity to attract and retain skilled professionals without immediate cash outflows.

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

  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 a powerful tool for startups and growing companies, helping to attract, motivate, and retain top talent while aligning employee interests with company success. By carefully structuring the ESOP pool, defining clear objectives, and maintaining compliance, companies can maximise the benefits of employee ownership. An effective ESOP pool provides both short- and long-term incentives for employees, making it a valuable asset in driving sustainable business growth.

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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