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Content Overview [ Contact us ](#contact-us-sidebar) #### Content Overview #### Not sure your ESOP financials would survive investor scrutiny? [Let's talk](https://calendly.com/consulttreelife/20min?utm_source=blogbannertreelife) #### Get in touch with us Your information is confidential and secure Or [Book a CONSULTATION](https://calendly.com/consulttreelife) Δ Blog Content Overview - [0.1 What does ESOP due diligence check in a funding round?](#What_does_ESOP_due_diligence_check_in_a_funding_round) - [1 What do ESOP due diligence services check, beyond the scheme document?](#What_do_ESOP_due_diligence_services_check_beyond_the_scheme_document) - [2 How is ESOP expense supposed to appear in the financial statements?](#How_is_ESOP_expense_supposed_to_appear_in_the_financial_statements) - [2.1 The two fair values founders confuse: grant-date accounting value and exercise-date tax value](#The_two_fair_values_founders_confuse_grant-date_accounting_value_and_exercise-date_tax_value) - [2.2 What happens to the expense when the plan is repriced or the pool changes size](#What_happens_to_the_expense_when_the_plan_is_repriced_or_the_pool_changes_size) - [2.3 When the grant comes from a foreign parent](#When_the_grant_comes_from_a_foreign_parent) - [3 Why do investors and founders disagree over the ESOP EBITDA add-back?](#Why_do_investors_and_founders_disagree_over_the_ESOP_EBITDA_add-back) - [4 What happens when ESOP expense was never booked at all?](#What_happens_when_ESOP_expense_was_never_booked_at_all) - - [4.0.1 Not sure your ESOP financials would survive investor scrutiny? Let’s Talk](#Not_sure_your_ESOP_financials_would_survive_investor_scrutiny_Let8217s_Talk) - [5 Where does the ESOP trust’s own balance sheet fit into diligence?](#Where_does_the_ESOP_trust8217s_own_balance_sheet_fit_into_diligence) - [6 How does the SH-6 register have to reconcile to the financials?](#How_does_the_SH-6_register_have_to_reconcile_to_the_financials) - [7 Does ESOP due diligence change for a company preparing to list?](#Does_ESOP_due_diligence_change_for_a_company_preparing_to_list) - [8 Common mistakes that cost founders time and money](#Common_mistakes_that_cost_founders_time_and_money) - [9 What Treelife’s ESOP due diligence services typically find](#What_Treelife8217s_ESOP_due_diligence_services_typically_find) - [10 Case Study](#Case_Study) - [11 FAQs on ESOP Due Diligence in India](#FAQs_on_ESOP_Due_Diligence_in_India) - - - [11.0.0.1 Regulatory references](#Regulatory_references) ESOP due diligence services cover the part of a funding or M&A review where an investor’s chartered accountants verify that your employee stock option cost is correctly reflected in your financial statements, not just correctly documented in your scheme rules. Most founders prepare the scheme file, the SH-6 register, and the board resolutions, and assume the accounting side takes care of itself. It rarely does. A stock option that was never expensed under Ind AS 102, or an EBITDA add-back that has no accounting basis, is one of the fastest ways to lose negotiating leverage in the final weeks before a round closes. This guide walks through what a financial due diligence team actually tests on the ESOP file, where the numbers most often break, and how to fix them before the data room opens. ### What does ESOP due diligence check in a funding round? ESOP due diligence verifies three linked things: that the scheme was approved and granted correctly under the Companies Act, that every grant’s fair value was expensed in the financial statements under Ind AS 102 or the ICAI Guidance Note, and that any EBITDA add-back for ESOP cost has an accounting basis the investor’s CA can trace to the ledger, not just a line in the pitch deck. ## What do ESOP due diligence services check, beyond the scheme document? ESOP due diligence is not one review, it is three overlapping ones, run by different people on the investor’s side, and founders usually prepare for only one of them. The **legal or secretarial workstream** checks whether the scheme was approved by shareholders under Section 62(1)(b) of the Companies Act 2013, whether Form MGT-14 was filed within 30 days of that resolution, and whether every allotment on exercise has a matching Form PAS-3. Treelife has covered this ground in detail in its guide on [secretarial documents for a funding round data room](https://treelife.in/compliance/secretarial-documents-for-a-funding-round-data-room/). The **tax workstream** checks perquisite computation at exercise, TDS deduction under Section 192, and eligibility for the Section 192(1C) deferral available to DPIIT-recognised startups. This is covered in Treelife’s [ESOP taxation guide](https://treelife.in/taxation/esop-taxation-in-india/). *A regulatory note: the Income-tax Act, 2025 replaced the Income-tax Act, 1961 with effect from 1 April 2026 and governs the current tax year. It reportedly carries the substantive perquisite and TDS rules forward unchanged, but section numbers are renumbered. This article cites the 1961 Act numbers, since that is how the underlying case law and most current practitioner commentary still frame these provisions, and flags the confirmed 2025 Act equivalent where one exists.* The **financial workstream**, the one this article is about, checks whether the fair value of every grant was actually recognised as an expense in the profit and loss account over the vesting period, whether the corresponding equity or liability entry is correctly carried on the balance sheet, whether a deferred tax asset was recognised where applicable, and whether any EBITDA normalisation for ESOP cost in the investor deck can be reconciled to the general ledger. A company can pass the legal review cleanly and still fail this one, because the scheme being validly approved says nothing about whether the accounting team ever booked the expense. **How the three workstreams differ** WorkstreamReviewed byPrimary questionGoverning frameworkLegal or secretarialInvestor’s counsel, company secretaryWas the scheme approved and every allotment filed correctlyCompanies Act 2013, Section 62(1)(b), MGT-14, PAS-3TaxInvestor’s tax advisor, company’s CAWas perquisite tax computed and TDS deducted correctlyIncome Tax Act 1961, Section 17(2)(vi), Section 192(1C); renumbered as Section 17(1)(d) of the Income-tax Act 2025, effective 1 April 2026FinancialInvestor’s CA, QoE teamWas the fair value expense booked and is the EBITDA add-back defensibleInd AS 102, ICAI Guidance Note on Share-based Payments 2020, Ind AS 12Founders that treat these as one file, usually the secretarial file, are the ones caught off guard when the investor’s CA asks for the option pricing model working paper three weeks into exclusivity. ## How is ESOP expense supposed to appear in the financial statements? Under Ind AS 102, Share-based Payment, a company measures the fair value of each option grant on the grant date, using an option pricing model such as Black-Scholes or a binomial lattice, and recognises that fair value as an employee compensation expense spread across the vesting period, with a corresponding credit to a “share options outstanding” account in equity, not a liability. Companies not yet [mandatorily on Ind AS](https://treelife.in/legal/ind-as-applicability-for-private-companies/) follow the ICAI Guidance Note on Accounting for Share-based Payments, 2020, which now also mandates the fair value method rather than the older intrinsic value option. The mechanics matter because they change how a diligence team reads your numbers: - **Grant date fair value is fixed.** Once the option pricing model computes fair value at grant, that number does not move even if the company’s valuation rises sharply before vesting. Investors know this and will ask for the working paper if your fair value looks low relative to your last priced round. - **Graded vesting front-loads the expense.** For a typical four-year vest with a one-year cliff and quarterly or annual tranches, the separate-grant method required under Ind AS 102 pushes a disproportionate share of the total cost into the earlier years, commonly over half the total charge in year one for a standard 25/25/25/25 schedule. A straight-line expense across four years understates cost in year one and is a technical non-compliance a diligence team will flag. - **Forfeitures adjust the expense, not reverse it retroactively in a simple way.** If an employee leaves before vesting, the standard requires the expense already recognised for unvested options to be reversed in the period of forfeiture, and the forfeiture assumption itself should be built into the original estimate, not bolted on later. - **The credit side sits in equity, not as a liability**, for equity-settled schemes. A diligence team checking your balance sheet for a “share options outstanding” or “employee stock option outstanding” reserve and finding nothing, despite active grants on the SH-6 register, is the single clearest sign the expense was never booked. A related and frequently missed point: a deferred tax asset can arise under Ind AS 12 on the difference between the accounting expense recognised over the vesting period and the tax deduction available only later, and computed differently, at the time of exercise under Section 37(1) of the Income Tax Act 1961 (renumbered under the Income-tax Act 2025, effective 1 April 2026; confirm the current clause before citing in a live filing) (a position supported by judicial precedent including the Supreme Court’s ruling in CIT v. Biocon Ltd.). Companies that expense ESOP cost correctly but never recognise the associated deferred tax asset are understating a legitimate balance sheet item, which itself becomes a diligence finding, just in the opposite direction from the more common one. ### The two fair values founders confuse: grant-date accounting value and exercise-date tax value A diligence team frequently finds a company using one valuation report to support two different numbers that the law does not intend to be the same. The Ind AS 102 fair value that drives the P&L expense is computed on the **grant date**, using an option pricing model (Black-Scholes or a binomial lattice), and it stays fixed for that grant regardless of what happens to the company’s value afterward. The fair market value that drives the employee’s **taxable perquisite at exercise**, under Rule 3(8) of the Income Tax Rules read with Section 17(2)(vi) of the Income Tax Act 1961 (Rule 15 of the Income-tax Rules 2026 and Section 17(1)(d) of the Income-tax Act 2025 from 1 April 2026), is a different number entirely: for an unlisted company it must be certified by a [SEBI Category-I merchant banker](https://treelife.in/startups/how-startup-valuation-works-in-india/), on a date not more than 180 days before the exercise date, and it is usually computed on a market-multiple or DCF basis, not an option pricing model. Using the merchant banker’s exercise-date valuation as a substitute for the accounting fair value at grant, or vice versa, understates or overstates the P&L expense and is one of the more technical findings a diligence team raises, precisely because both numbers sit in the same file and look interchangeable to a founder who has not been told they answer different questions. ### What happens to the expense when the plan is repriced or the pool changes size Down rounds and retention pressure lead many Indian startups to reprice underwater options, extend vesting, or change grant sizes after the original grant date. Ind AS 102 treats each of these as a modification, and the accounting is asymmetric in a way that surprises founders who assume a cheaper deal for employees also means a cheaper number on the books. EventWhat Ind AS 102 requiresEffect on the diligence fileRepricing to a lower exercise price (upward modification)The incremental fair value created by the modification is computed and expensed over the remaining vesting period, on top of the original grant-date charge, which continues unchangedTwo fair value working papers now exist for one grant, both need to be on file, and the incremental charge needs its own scheduleReducing the number of options or vesting benefit (downward modification)The company continues to recognise at least the original grant-date fair value as if the modification had not occurred; the reduced benefit does not reduce the expense below that floorA diligence team checking whether a “cost saving” repricing actually reduced the P&L charge, and finding that it legally cannot, will treat any model that assumes otherwise as an errorCancellation without a replacement grantAny unrecognised expense for the cancelled grant is accelerated and expensed immediatelyA forfeiture and a cancellation are not the same event for accounting purposes, and using forfeiture treatment for what was actually a cancellation understates the current period’s expenseBonus issue, stock split, or rights issue after grantThe scheme’s anti-dilution clause, if drafted, determines the adjustment to the number of options and exercise price; Ind AS 102 requires the adjusted award’s fair value to be assessed for any incremental costA scheme with no anti-dilution clause, or a corporate action implemented without a documented adjustment calculation, is a recurring finding in companies that have raised multiple rounds### When the grant comes from a foreign parent Companies structured with a foreign holding entity, commonly a US Delaware or Singapore parent above an Indian operating subsidiary, often grant options in the parent’s stock to Indian employees rather than running a separate Indian scheme. The Indian subsidiary still has to recognise its own Ind AS 102 expense in its standalone financial statements for the value of services received, even though the shares themselves are issued by the parent, and that standalone charge needs to reconcile to the parent’s own IFRS 2 or US GAAP ASC 718 expense allocated to the Indian entity. A diligence team reviewing a [flipped structure](https://treelife.in/legal/flip-structure-for-indian-startups/) checks specifically for this reconciliation, since a mismatch between the group’s mirror-grant allocation and the Indian standalone books is a common gap in companies that manage the parent-level cap table on one system and the Indian books on another. This sits alongside, and is separate from, the FEMA reporting obligation on the Indian employee covered elsewhere in this guide. ## Why do investors and founders disagree over the ESOP EBITDA add-back? Founders routinely present ESOP expense as a non-cash add-back to EBITDA in their fundraise deck, on the logic that it does not consume cash the way salary does. Investors’ quality-of-earnings teams push back on this add-back far more often than founders expect, and the disagreement is rarely resolved in the founder’s favour without documentation. The add-back is defensible when it is presented consistently, disclosed clearly, and reconciles to the actual Ind AS 102 or Guidance Note expense in the audited financials, not a management estimate that differs from the books. It becomes indefensible, and gets stripped out of the EBITDA the investor prices the round on, in three recurring situations. **Where the ESOP EBITDA add-back typically survives or fails diligence** ScenarioInvestor’s likely positionWhat protects the founder’s positionESOP expense booked under Ind AS 102, add-back matches the P&L line exactlyAdd-back generally accepted, treated as standard SaaS-comp normalisationConsistent treatment across all periods presented, disclosed in the model’s reconciliation noteESOP expense never booked, but deck shows an add-back anywayAdd-back rejected outright, EBITDA restated downward, and historical non-compliance becomes a separate findingNone, until the expense is actually booked and restatedESOP pool re-priced upward just before the round to justify a lower reported costFair value working paper requested, add-back challenged as designed around the raiseContemporaneous, arm’s length valuation report from a registered valuer, not a number set to fit the deckCash-settled stock appreciation rights (SARs) treated as equity-settled for a lower chargeReclassified as a liability under Ind AS 102, remeasured to fair value each period, EBITDA impact increasesCorrect classification from grant date, not adjusted only when diligence asksThe pattern across all four rows is the same: an add-back that traces cleanly to booked, auditable numbers survives. An add-back that exists only in the model does not, and once an investor’s CA has caught one unsupported normalisation, every other adjustment in the model gets reviewed with far less trust than it would have otherwise. ## What happens when ESOP expense was never booked at all? This is the single most common financial finding Treelife encounters on ESOP due diligence engagements, and it is more common in companies that have grown fast on the back of a strong product than in slower-growing ones, simply because fast-growing finance teams are usually stretched thinest on exactly this kind of non-cash technical accounting. The correction is a prior period restatement, not a forward-looking fix. If the company has been granting options for two or three years without expensing them, the finance team, working with the statutory auditor, must go back to each grant date, obtain or reconstruct the fair value working paper for that date (this is where an undated, backdated, or missing valuer’s report becomes a serious problem, not just a paperwork gap), compute the cumulative expense that should have been recognised through the vesting period to date, and restate retained earnings and the current period’s P&L accordingly. This typically increases historical expense and reduces historical profit or increases historical loss, which in turn reduces the EBITDA the investor is willing to price the round against, unless the correction is completed and disclosed before the [term sheet’s exclusivity period](https://treelife.in/legal/term-sheets-in-india/), rather than discovered during it. - **The restatement itself is not the deal-killer.** Investors expect some historical accounting gaps in a startup that has grown without a full-time controller for most of its life. What damages a founder’s position is the gap being found by the investor’s CA rather than disclosed by the company first. - **The valuer’s report is the critical document.** Under Rule 11UA of the Income Tax Rules for tax purposes (renumbered under the Income-tax Rules notified alongside the Income-tax Act 2025, effective 1 April 2026; confirm the current rule number before citing), and under Ind AS 102 or the ICAI Guidance Note for accounting purposes, the fair value at each grant date needs a contemporaneous basis. A valuation report dated after the grant date, prepared specifically to support a restatement, invites more scrutiny than an honest gap. - **Timeline matters more than most founders assume.** A restatement across two to three years of grants, involving option pricing recomputation and auditor sign-off, typically takes four to eight weeks when the underlying grant data (dates, exercise prices, headcount, forfeitures) is already clean in the SH-6 register. It takes considerably longer when that register itself needs to be reconstructed first. > #### Not sure your ESOP financials would survive investor scrutiny? [Let’s Talk](javascript:void(0)) [ ](https://calendly.com/consulttreelife/20min?utm_source=blogbannertreelife) ## Where does the ESOP trust’s own balance sheet fit into diligence? Companies that route ESOPs through an employee benefit trust rather than direct allotment create a second set of financial statements that diligence teams review separately: the trust’s own accounts. Ind AS 102 does not prescribe an explicit approach for accounting for the trust in the sponsoring company’s separate financial statements, which means the accounting policy adopted has to be a considered, disclosed judgement, not a default. In the consolidated financial statements, the question shifts to whether the sponsoring company controls the trust under Ind AS 110, which if answered yes, brings the trust’s shares, loans, and cash entirely onto the group balance sheet. Treelife’s guide on the [direct route versus trust route for ESOP in India](https://treelife.in/taxation/direct-route-vs-trust-route-for-esop-in-india/) covers the governance and Rule 16 compliance angle in depth. On the financial side specifically, diligence teams look for whether the loan the company extended to fund the trust is correctly disclosed as a related party transaction, whether the trust’s own books are audited on the same schedule as the company’s, and whether shares held by the trust but not yet allotted to employees are correctly excluded from the company’s own issued and outstanding share count in the cap table reconciliation. ## How does the SH-6 register have to reconcile to the financials? The SH-6 register is a statutory internal record under Rule 12(9) of the Companies (Share Capital and Debentures) Rules 2014, tracking every grant, vesting event, exercise, and lapse. It is not an accounting document, but a financial due diligence team uses it as the primary source to test whether the accounting matches reality, because it is the only place all grant-level data lives in one file. The reconciliation a diligence team runs is mechanical and unforgiving of small gaps, and it does not stop at the statutory register. Where the company maintains its [cap table](https://treelife.in/finance/cap-table-for-startups/) on a dedicated platform rather than a spreadsheet, the diligence team also checks that the platform’s option ledger, the SH-6 register, and the financial statements all show the same grant, vesting, and exercise numbers, since a mismatch between the software and the statutory register is treated the same way as a mismatch within the register itself. 1. Total options granted per the SH-6 register, cross-checked against the cumulative fair value expensed in the financials at the applicable per-option rate for each grant tranche. 2. Total options forfeited or lapsed per the register, cross-checked against the expense reversal recorded in the period each forfeiture occurred. 3. Total options exercised, cross-checked against the corresponding share allotment in Form PAS-3 and the increase in issued share capital on the balance sheet. 4. The closing outstanding option balance on the register, cross-checked against the disclosed but unvested option pool disclosed in the directors’ report under Rule 12(9), which mandates disclosure of options granted, vested, exercised, and lapsed each year. 5. Every grant on the register backed by a signed grant letter, signed by an authorised signatory of the company and acknowledged by the employee. A grant recorded on the register but never reduced to a signed letter, or signed only on one side, is treated as an unresolved allotment risk, since the register itself is not the legal instrument, the grant letter is. A register that is even six months out of date at the time diligence begins usually cannot be reconciled cleanly to any of these five checks, and reconstructing it retrospectively, matching old board minutes to grant dates, exercise prices, and missing signatures, is one of the slowest and most disruptive items on a diligence timeline precisely because it sits underneath both the legal and the financial workstream at once. ## Does ESOP due diligence change for a company preparing to list? Yes, and the change is less about the accounting, which stays governed by Ind AS 102 regardless, and more about a fourth workstream that only appears once an IPO or listing is in view: insider trading compliance under the SEBI (Prohibition of Insider Trading) Regulations 2015. The grant and vesting of ESOPs is not treated as trading under these regulations, and SEBI’s guidance note has confirmed that exercise is also excluded from the contra-trade restriction, but the sale of shares acquired on exercise is trading in the full sense, and that changes what a diligence team, and later a merchant banker preparing the offer document, needs to see. For a company heading toward a listing, three additional checks get layered onto the financial workstream covered above: - **Designated persons list and trading window compliance.** Every employee holding ESOPs who qualifies as a designated person under the company’s own PIT code needs pre-clearance for the sale of shares acquired on exercise, even though the exercise itself is exempt. - **Structured digital database (SDD) entries for ESOP grant decisions.** Board and committee deliberations on ESOP grants to designated persons need to be logged in the company’s SDD with time stamps, since this is one of the first things SEBI’s own inspection checks during a listing review. - **DRHP-level disclosure of the ESOP cost.** The draft red herring prospectus needs the same Ind AS 102 expense schedule this article has been describing, presented on a basis that reconciles to the restated financials in the offer document, not to the management figure used internally before the listing was contemplated. Companies that are still several years from a listing do not need to build this workstream out today, but a due diligence team reviewing a late-stage pre-IPO round will test for it, and a designated persons list that does not exist yet is a faster fix started early than discovered during an IPO readiness review. ## Common mistakes that cost founders time and money **Expensing ESOP on a straight-line basis instead of the separate-grant method.** Straight-line is simpler to compute but understates year-one expense for any graded vesting schedule, which is the norm in India. Auditors increasingly flag this on first review, forcing a mid-diligence recomputation. **Treating the EBITDA add-back as automatic.** As covered above, an add-back with no traceable Ind AS 102 expense behind it gets reversed, and the reversal often comes with a valuation haircut larger than the add-back itself, because it signals a broader quality-of-earnings concern. **Backdating or reconstructing the option pricing valuation report.** A fair value report prepared after the fact, timed to support a restatement or an EBITDA position, is treated by most investor CAs as a red flag on the entire finance function, not just the ESOP line. **Letting the SH-6 register drift out of sync with actual board approvals.** Every grant, exercise, and forfeiture has to be logged contemporaneously. A register rebuilt from memory during diligence rarely survives cross-checking against board minutes without discrepancies. **Ignoring the deferred tax asset on ESOP.** Companies focused on getting the expense booked correctly sometimes miss the corresponding deferred tax asset under Ind AS 12, understating net assets in a way that, while conservative, is still a technical non-compliance a careful diligence team will note. **Assuming a [down-round repricing](https://treelife.in/finance/bridge-round-vs-priced-round/) lowered the P&L charge.** As the modification table above shows, Ind AS 102 requires the original grant-date fair value to keep being expensed regardless of the repricing, plus any incremental cost from the new terms. A model built on the assumption that repricing saved money on the books gets corrected the first time an auditor reviews it. **Using the merchant banker’s exercise-date FMV as the grant-date accounting fair value, or the reverse.** These answer different questions under different rules and are not interchangeable. A diligence team that finds one valuation report supporting both the P&L expense and the perquisite computation will ask which number was actually used for which purpose, and a founder without a clear answer loses time explaining a mix-up that a separate working paper for each would have avoided. > Before your next board pack, see how Treelife structures ESOP scheme design to stay diligence ready from the first grant: [ESOP scheme design in Indian startup tax](https://treelife.in/taxation/esop-scheme-design-in-indian-startup-tax/). ## What Treelife’s ESOP due diligence services typically find In the ESOP financial due diligence engagements we have run at Treelife ahead of Series A and Series B rounds, the single most recurring finding is not fraud or deliberate misstatement, it is simply that the ESOP fair value expense was never booked because the finance function, often a single controller managing books, GST, and payroll, never had a dedicated review point for share-based payment accounting. The scheme document exists, the board approved it, the SH-6 register is reasonably current, and the accounting is still absent, because nobody’s job description specifically included checking whether Ind AS 102 applied. The second most common finding is the EBITDA add-back mismatch: a founder’s model shows a clean, round ESOP add-back figure that does not tie to any specific ledger entry, usually because the number was estimated once for an early investor conversation and never updated as new tranches vested. Once an investor’s CA finds this gap on the ESOP line, every other normalisation in the model gets a harder look, which is the real cost, beyond the ESOP figure itself. (Section 62(1)(b), Companies Act 2013; Ind AS 102, Share-based Payment; ICAI Guidance Note on Accounting for Share-based Payments, 2020.) > If your ESOP pool has been active for more than a year and your finance team has never run a dedicated Ind AS 102 review, that is worth checking before, not during, your next term sheet: see Treelife’s broader [financial due diligence checklist for startups](https://treelife.in/finance/financial-due-diligence-checklist-for-startups/). ## Case Study **Situation:** A Series A SaaS company based in Bengaluru had granted ESOPs across three tranches over two years, all validly approved by the board and shareholders, with a current SH-6 register. **Challenge:** None of the three tranches had been expensed under Ind AS 102. The founder’s model showed a flat ₹40 lakh annual EBITDA add-back for ESOP that did not match any ledger entry, and the fair value working papers for two of the three tranches did not exist. **What Treelife did:** Reconstructed grant-date fair value for all three tranches using contemporaneous valuation inputs, computed the separate-grant expense for each tranche, prepared the prior period restatement working with the statutory auditor, and rebuilt the EBITDA reconciliation note to tie the add-back exactly to the restated P&L. **Outcome:** The restatement was disclosed to the investor’s CA before their review began rather than discovered during it. The EBITDA add-back, now fully supported, was accepted without adjustment. Diligence on the ESOP file closed in three weeks against an initial six-week estimate. No escrow was set aside against the ESOP line. > Get your ESOP financials tested before an investor’s CA does. Book a 30-minute call with Priya Kapasi on Treelife’s ESOP due diligence services to walk through your fair value working papers and EBITDA add-back before your next term sheet. ## FAQs on ESOP Due Diligence in India **Q: What does ESOP due diligence cost as part of a funding round?** A: The investor’s own CA and legal reviewers are paid by the investor, typically deducted from the investment at closing. The company’s cost of getting its own ESOP financials, valuation reports, and SH-6 register in order ahead of that review usually runs a fraction of the Series A financial due diligence budget, commonly ₹1-4 lakhs depending on how many grant tranches need fair value reconstruction. **Q: How long does ESOP financial due diligence take?** A: Two to three weeks if the SH-6 register is current and every fair value working paper already exists. Four to eight weeks if expense recognition or the register itself needs to be reconstructed retrospectively. **Q: Is ESOP expense tax deductible for the company?** A: Yes. The Supreme Court in CIT v. Biocon Ltd. confirmed ESOP discount is an allowable deduction under Section 37(1) of the Income Tax Act 1961 (renumbered under the Income-tax Act 2025, effective 1 April 2026; confirm the current clause before citing), computed and allowed in the year of vesting, subject to the deduction not exceeding the amount actually taxed in the employees’ hands. **Q: What documents does an investor’s CA ask for on the ESOP file?** A: The board and shareholder resolutions approving the scheme, Form MGT-14 and PAS-3 filings, the current SH-6 register, the option pricing model working paper for each grant date, the P&L expense schedule by tranche, and the EBITDA reconciliation note if an add-back is presented. **Q: How does FEMA apply if ESOP is granted to an Indian subsidiary’s employees by a foreign parent?** A: The employee receives shares of a foreign company, which is governed by the Foreign Exchange Management (Overseas Investment) Rules, and requires annual return filing by the Indian resident employee and, in most structures, reporting by the Indian subsidiary if it operates as the administering entity. This is reviewed as a separate FEMA compliance item, distinct from the domestic accounting treatment covered in this article. **Q: Do co-founders holding ESOPs get treated differently in diligence?** A: Grants to promoter-directors attract closer scrutiny on whether shareholder approval followed the correct related-party process and whether the exercise price reflects an arm’s length fair value, since a founder-favourable pricing is more likely to be challenged than a standard employee grant. **Q: Is ESOP treated differently for a DPIIT-recognised startup?** A: The accounting treatment under Ind AS 102 or the ICAI Guidance Note is the same regardless of DPIIT status. The difference is entirely on the employee’s tax side, where DPIIT recognition unlocks the Section 192(1C) deferral of perquisite tax to a later trigger event. **Q: What happens to unvested ESOPs if the funding deal falls through?** A: Nothing changes on the accounting side purely because a deal did not close. Vesting continues per the scheme, and expense continues to be recognised over the remaining vesting period regardless of fundraising outcomes, since vesting is tied to service, not to a transaction. **Q: What happens to the ESOP pool in an acquisition rather than a funding round?** A: The acquisition agreement typically specifies accelerated vesting, rollover into acquirer equity, or cash-out at the difference between deal price and exercise price. Each treatment has a distinct accounting entry, and diligence teams check that the scheme document actually permits whichever treatment the deal contemplates, since many older scheme documents are silent on acquisition scenarios. **Q: Can an NRI or foreign national exercise ESOPs in an Indian private company?** A: Yes, subject to the pricing and reporting requirements under the FEMA (Non-Debt Instruments) Rules for share allotment to a person resident outside India, which diligence teams check separately from the accounting treatment. **Q: Does repricing underwater options during a down round reduce the ESOP expense?** A: No. Ind AS 102 requires the original grant-date fair value to continue being expensed regardless of the repricing, with any incremental fair value created by the more favourable new terms added on top and expensed over the remaining vesting period. **Q: How is ESOP accounted for when an Indian subsidiary’s employees hold options in a foreign parent company?** A: The Indian subsidiary still recognises its own Ind AS 102 expense for the value of services received, which needs to reconcile to the portion of the parent’s IFRS 2 or US GAAP charge allocated to the Indian entity. This is checked separately from the FEMA reporting obligation on the employee. **Q: How does an under-provisioned ESOP pool affect diligence?** A: If the pool authorised in the Articles of Association is smaller than the grants outstanding on the SH-6 register, this is an allotment-validity problem under the Companies Act, not primarily an accounting one, and it is usually resolved by a shareholder resolution expanding the pool before the round can close. **Q: What is the difference between ESOP due diligence and an ESOP valuation report?** A: The valuation report is one input the diligence team tests, it establishes the fair value at a specific grant date. Due diligence is the broader review of whether that fair value was correctly translated into an expense, a balance sheet entry, and a defensible EBITDA position across the full life of the scheme. ##### **Regulatory references** - Indian Accounting Standard (Ind AS) 102, Share-based Payment, Companies (Indian Accounting Standards) Rules 2015 - ICAI Guidance Note on Accounting for Share-based Payments, 2020 - Indian Accounting Standard (Ind AS) 12, Income Taxes - Indian Accounting Standard (Ind AS) 110, Consolidated Financial Statements - Companies Act 2013, Section 62(1)(b) and Section 454 - Companies (Share Capital and Debentures) Rules 2014, Rule 12(9) [ Read as Markdown](https://treelife.in/finance/esop-due-diligence-in-india/?format=markdown) ### Related posts: 1. [What Is An Income Statement?](https://treelife.in/finance/what-is-an-income-statement/ "What Is An Income Statement?") 2. 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