An investor may ask for a 10% option pool and make it sound like a hiring detail. Whether that pool is created before or after the investment can shift its entire dilution cost onto founders or share it with new investors.
The pool also needs a lawful scheme, approvals, grant records and a credible hiring plan. A spreadsheet promise is not an issued employee option.
Quick Answer
Before creating an ESOP pool, model the fully diluted cap table and agree whether the pool is included in the pre-money or post-money valuation. Indian companies must follow the Companies Act and Share Capital and Debentures Rules for scheme approval, eligible employees, grants, vesting and exercise. Tax and FEMA questions may arise, particularly for non-resident employees or foreign-owned startups.
1. Size the pool from a hiring plan
A round-number pool copied from a term sheet may be too large or too small. List the roles the company expects to hire before the next financing, likely grant ranges, attrition assumptions and expected refresh. Distinguish unallocated pool from options already granted.
Show the ownership effect at grant and on exercise. A pool is an economic promise even before shares are issued. If convertibles are outstanding, include their likely conversion in the fully diluted model.
- Build role-by-role grant forecast.
- Separate issued, granted and reserved securities.
- Model conversion and attrition.
2. Negotiate pre- versus post-money
When the investor requires a pool top-up inside the pre-money valuation, existing owners usually bear more dilution. A post-money pool may spread that effect differently. Both parties should see the same cap-table model before signing.
The term sheet should define the pool numerator and denominator, treatment of unused options and future refreshes. A vague statement that the company “will maintain 10% ESOP” can produce disagreement at closing.
- Show both dilution scenarios.
- Define fully diluted share count.
- Record pool top-up mechanics.
3. Create the scheme lawfully
MCA’s Share Capital and Debenture Rules include Rule 12 on employee stock options. Check company eligibility, shareholder approval, explanatory disclosures, employee eligibility and the scheme’s terms. The grant letter should be consistent with the approved scheme.
Vesting, exercise price, lapse, leaver treatment and corporate-event provisions belong in writing. Keep an option register and grant evidence. Do not issue options to a person who falls outside the permitted employee category without checking the specific legal route.
- Prepare scheme and approval papers.
- Use consistent grant letters.
- Maintain an option register.
4. Exercise, tax and foreign employees
A grant is not the same as exercise or share allotment. When an employee exercises, the company may need to issue shares, update registers, make filings and deal with payroll tax. The employee should understand that liquidity may be limited.
Foreign employees or a foreign-owned company can create FEMA and cross-border tax questions. RBI’s foreign-investment direction also measures foreign investment on a fully diluted basis for certain purposes. Review these facts before assuming one domestic arrangement covers every employee.
- Calendar vesting and exercise events.
- Review employee tax at relevant dates.
- Check FEMA for non-residents.
How to record the decision
A short decision note should explain why the chosen route fits the facts, which authority controls the point, what was checked and which assumptions remain open. For ESOP before funding, the note should also identify the responsible person, the next filing or approval event and the evidence that supports each conclusion.
Keep the note with board materials, agreements, portal acknowledgements and professional advice. This simple record helps founders answer investor, lender and regulator questions without reconstructing the reasoning months later. Update it whenever the business model, ownership, money flow, instrument terms or scheme status changes.
Documents to keep in one working file
The exact set depends on the transaction, but the working file should make the facts easy to test. Start with these records and add authority-specific forms or declarations where required:
- Forecast hires and grants.
- Model pool under both valuation treatments.
- Agree term-sheet definition.
- Approve the scheme under current law.
- Issue documented grants and keep register.
Use dated versions and keep a clear approval trail. A missing email, valuation input or portal receipt can become a material due-diligence issue even when the commercial decision itself was sound.
Decision table
Use the facts of the proposed transaction to test each row before choosing a route.
| Pool decision | Why it matters |
|---|---|
| Pool size | Hiring capacity and unused dilution |
| Pre-money treatment | More dilution can fall on existing holders |
| Post-money treatment | Economics shared differently |
| Scheme terms | Vesting, exercise, leavers and records |
Practical checklist
Work through these steps using dated documents, not assumptions made in a pitch deck.
- Forecast hires and grants.
- Model pool under both valuation treatments.
- Agree term-sheet definition.
- Approve the scheme under current law.
- Issue documented grants and keep register.
- Review exercise, tax and FEMA events.
Mistakes that create avoidable delay
The following shortcuts frequently create avoidable legal or filing work later.
- Agreeing to a percentage without a fully diluted model.
- Promising options before scheme approval.
- Treating grant, vesting and share allotment as one event.
When professional review is useful
A fact-specific review should test the chosen route, evidence and filing sequence before money or customer commitments make a correction expensive.
For a fact-specific review, share the proposed activity, ownership, funding instrument and present stage with Sunny G And Co. at contact@cssunnygupta.com. The scope and professional fee should be agreed only after the facts and required filings are clear.
Related service paths
If the issue involves actual filings or structuring, these service pages describe the relevant scope of work. They do not change the eligibility and approval tests explained above; the right route still depends on the company’s documents and intended activity.
Official sources and last review
This article was last reviewed on 15 September 2026. Rules, portal status and filing practices can change, so check the current authority before acting.
