What the pool is and how big it should be
An ESOP pool is a block of shares a company sets aside to grant to employees, advisors and directors over time. On an Indian cap table it is created as reserved, fully-diluted capital, so it dilutes existing shareholders whether or not the options are ever granted. Sizing it well is therefore a real decision, not an afterthought.
The common range is 10 to 15 percent of fully-diluted capital. The right number is the one that covers your hiring plan until the next funding round, at which point the pool is usually revisited and topped up. A pool that is too small forces awkward mid-cycle expansions, while one that is too large dilutes founders more than necessary today. Remember from the fully-diluted lesson that investors often push to enlarge the pool pre-money, which shifts that dilution onto the founders.
The legal basis for private companies
ESOPs in a private company are governed by Section 62(1)(b) of the Companies Act, 2013, read together with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. This is the framework that makes an option pool valid and enforceable.
Board and shareholder approval
Creating the pool follows a defined approval path.
- The board approves the ESOP scheme and its terms.
- The shareholders approve the scheme. Rule 12 requires a special resolution. However, MCA notification G.S.R. 464(E) dated 5 June 2015 exempts private companies and permits approval by an ordinary resolution instead.
- Because Rule 12 itself was never amended to match that exemption, the safe and common practice is still to pass a special resolution to avoid any ambiguity.
- The company then files the resolution with the Registrar of Companies and maintains the required statutory register of options.
Alongside the resolutions, the explanatory statement placed before shareholders must disclose the key terms of the scheme, including the total number of options, the classes of employees who are eligible, the pricing, and the vesting conditions, so that approval is given on a fully informed basis. Cutting corners on these disclosures is exactly the kind of gap a later diligence exercise will find.
Who can and cannot receive options
Rule 12 defines eligibility. Options may go to permanent employees and directors, but the rule specifically excludes promoters and directors who hold more than 10 percent of the equity shares of the company. There is a significant carve-out for startups: a company recognised by the Department for Promotion of Industry and Internal Trade, or DPIIT, is exempt from this exclusion for ten years from the date of its incorporation. This is what allows many founder-led startups to grant ESOPs to founders who cross the 10 percent threshold.
Rule 12 also sets a floor on timing: there must be a minimum of one year between the grant of an option and its vesting, which is the statutory version of the one-year cliff.
Founder takeaways
Treat the pool as a scarce resource. Size it to a real hiring plan rather than a round number, understand that every expansion dilutes you as well as your co-founders, and follow the approval and filing steps precisely, since an improperly created pool can unravel exactly when a diligence process is looking hardest. Getting the governance right early is far cheaper than fixing it under the pressure of a financing.