How to handle ESOPs when an employee leaves

Employee departure with unvested or vested but unexercised options is one of the most common sources of ESOP disputes and complexity. Having clear policies and documented processes prevents conflict and ensures your cap table stays clean.

Unvested options: when an employee leaves (for any reason), unvested options lapse. This is standard and should be clearly stated in the grant letter and the ESOP scheme. The lapsed options return to the pool and can be regranted. This is the purpose of the cliff — if an employee leaves in year 1, before any options vest, they receive nothing.

Vested but unexercised options: this is where most complexity arises. Standard company ESOP schemes give departing employees a 90-day exercise window — they must exercise their vested options within 90 days of leaving or forfeit them. The trend in Indian startups is to extend this window (12 months, 5 years, or even until the company exit) to be fairer to employees who've created value. Decide your policy in advance and document it.

Good leaver vs. bad leaver provisions: many ESOP schemes distinguish between 'good leavers' (resign voluntarily, retire, or are made redundant) and 'bad leavers' (dismissed for cause, violate non-compete). Good leavers typically retain their vested options; bad leavers may forfeit even vested options. These provisions should be explicit in the scheme and grant letters.

Tax at departure: if a departing employee exercises options within the exercise window, the perquisite tax is triggered at exercise. The company must calculate TDS on the perquisite income. If the employee cannot pay the exercise price or TDS, the company needs a process to handle this — some companies allow cashless exercise (the employee authorises the company to sell enough shares to cover the exercise price and TDS).

Documentation: every departure involving ESOP should be formally documented — the date of departure, the number of vested and unvested options, the exercise window, and the outcome (exercised, forfeited, or extended). Maintain this in your ESOP register.

PF, ESIC & STATUTORY COMPLIANCE