Most founders discover ESOP compliance backwards. They promise options to a key hire, shake hands, and only later ask whether the paperwork matters. It does. Under Indian law, an ESOP issued without the proper approvals is not just sloppy - it is legally fragile. And fragile options are worse than no options, because everyone acts as if they are real.

The law lives in two places. Section 62(1)(b) of the Companies Act 2013 gives companies the power to offer shares to employees under a stock option scheme. Rule 12 of the Companies (Share Capital and Debentures) Rules 2014 lays down how. This article turns those provisions into a working checklist: the exact sequence, the documents, the registers, and the traps. Follow it in order and your scheme will survive due diligence. Skip steps and you are building on sand.

Think of it like constructing a building. Nobody pours concrete before the building plan is sanctioned. The sanction - drawings approved, file stamped - comes first, and every floor follows it. An ESOP scheme works the same way. The shareholder approval and the scheme document are your sanctioned plan. The individual grants are the floors. Build floors without a sanctioned plan and the whole structure is unauthorised - which is exactly what an investor's lawyer will tell you during due diligence.

Step 1: the board designs the scheme

It starts in the boardroom, not with a grant letter. The board discusses and approves the draft ESOP scheme: who is eligible, how many options in total, the vesting design, the exercise price formula, the exercise window, and what happens when employees leave. The board then resolves to place the scheme before shareholders. Nothing has been granted yet. This is the drawing-board stage, and rushing it is the most common mistake - the scheme document written here governs every grant for years.

Step 2: shareholders sanction it by special resolution

The company convenes a general meeting with at least 21 days' notice. The notice must carry an explanatory statement disclosing the specifics the law demands: the total number of options to be granted, the class or classes of employees entitled, the vesting requirements and vesting period, the exercise price or the formula for arriving at it, the maximum period within which options vest, and the lock-in if any. Then the shareholders vote, and the resolution needs 75% of votes cast in favour - a special resolution, not an ordinary one.

Why does the law insist on shareholder approval? Because every exercised option dilutes existing shareholders. The people being diluted get a vote on the dilution. That is the entire logic, and it is sound. A scheme created by board resolution alone, without the shareholders' 75%, has no legal legs.

One point founders miss: the sanction is specific. If you later want to change the scheme's core terms - extend vesting, reprice underwater options, widen the employee pool - that variation needs a fresh special resolution. The sanctioned plan cannot be quietly redrawn mid-construction.

Step 3: write the scheme document properly

This is the constitution of your plan, and it deserves care. A complete scheme document covers: eligibility criteria (who qualifies, and the statutory exclusions below); the total option pool; the vesting schedule with exact mechanics - cliff, frequency, and the one-year statutory minimum before anything vests; the exercise price or pricing formula; the exercise window after vesting and after exit; leaver provisions distinguishing resignation, retirement, death, and misconduct; treatment of options on merger, acquisition, or IPO (acceleration or conversion - decide now, not during the deal); and the administration of the scheme (usually a compensation committee or the board itself).

Templates are starting points, not finished products. I have seen schemes copied wholesale from another company's document - wrong vesting, wrong exercise windows, leaver clauses that contradicted the company's own HR policy. Your cap table, your hiring plan, and your exit timeline should shape the final document. A two-hour review by someone who has drafted these before pays for itself many times over.

Step 4: grant in writing, employee by employee

With the scheme sanctioned, the company issues individual grant letters. Each letter states the number of options, the exercise price, the vesting schedule with dates, the exercise window, and the leaver provisions. Verbal promises are worth the paper they are printed on - none. Every grant must trace back to the sanctioned scheme: same pool, same terms, no side deals. Side deals are where schemes quietly break, because the board's report disclosures (Step 6) will eventually expose grants the scheme never authorised.

Who cannot receive ESOPs

Rule 12 excludes two categories, and private companies stumble here most. First, any employee who is a promoter or belongs to the promoter group. Second, any director who holds more than 10% of the equity, directly or indirectly through relatives or a body corporate. The logic is clean: ESOPs are for employees, not a route for owners to reward themselves through the employee door. Separately, the Act bars ESOPs to independent directors entirely.

The important carve-out: DPIIT-recognised startups may issue ESOPs to promoters and promoter-group employees for ten years from incorporation. The government relaxed this deliberately so startup founders can participate in the wealth they create. The relaxation is conditional - the company must actually hold DPIIT recognition and be within the ten-year window - so document the eligibility in the scheme file rather than assuming it.

Step 5: maintain the SH-6 register from day one

The company must maintain a Register of Employee Stock Options in Form SH-6. This is not a spreadsheet you reconstruct at year-end. It records, grant by grant: the employee's name, the options granted, the vesting dates, options vested, options exercised, the exercise price paid, options lapsed or forfeited, and the balance outstanding. Every movement in the life of every option lands here, contemporaneously. The Registrar of Companies can call for it, auditors review it, and investors' lawyers read it line by line during due diligence. A clean SH-6 is the single fastest way to signal that the scheme is real. An empty or reconstructed one signals the opposite.

Step 6: disclose in the board's report, every year

ESOPs are a shareholder matter, so they are reported to shareholders annually. The board's report must disclose: options granted during the year, options vested, options exercised, options lapsed, the exercise price, and employee-wise details for senior managerial personnel and any employee receiving 5% or more of the year's grants (or 1% or more of issued capital at grant). These disclosures are where informal schemes get caught - grants that never went through a special resolution surface here, in public, in a filed document. Keep the disclosures honest and complete; they are also your proof, years later, that the scheme ran properly.

The failure sequence I see most often

Options promised in an offer letter. No scheme document. No special resolution. Vesting tracked on a spreadsheet. SH-6 empty. Board's report silent. Then a funding round arrives, the investor's due diligence asks for the ESOP file, and the whole thing gets rebuilt backwards - resolutions ratified late, registers reconstructed from memory, disclosures corrected in revised filings. It is usually fixable. It is also completely avoidable, and the rebuild always costs more than doing it right - in professional fees, in delayed closings, and in credibility with the incoming investor.

What to do next

If you are planning a scheme: board design first, then the 21-day notice and special resolution, then the scheme document in final form, then grant letters, with the SH-6 register opened before the first grant and the annual board's report disclosures diarised. If you already granted options informally: regularise now - ratifying resolution, scheme document, reconstructed register with supporting evidence - before a funding round or an employee dispute forces the issue on someone else's timetable.

When we help private companies structure ESOP schemes in India, the order is fixed: resolution, scheme document, valuation, grant letters, registers, disclosures. Call us on +91 7982659624, write to info@complykart.com, or message us on WhatsApp. For the employee-side view - what the grant means in your hands and how the tax on ESOPs in India works with worked numbers - read our complete guide to ESOPs in India.