Employee Stock Ownership Plan (ESOP) in India: How Does It Work for Startups & Employees?

An Employee Stock Ownership Plan (ESOP) is more than just a financial instrument — it’s a strategy that bridges company success and employee growth. ESOPs allow employees to own a piece of the company they work for, aligning their goals with the company’s long-term vision. In recent years, ESOPs have become a popular tool for startups and corporations alike, helping them attract and retain top talent in competitive markets. Learn how Bulk Payment solutions are also transforming enterprise-level financial operations.

Table of Contents

1.     The Concept of Employee Ownership

2.     How ESOPs Work

3.     Types of ESOPs

4.     ESOPs in Startups

5.     ESOPs in India

6.     Advantages of ESOPs

7.     Challenges and Risks of ESOPs

8.     How Companies Value ESOPs

9.     Taxation of ESOPs in India

10. ESOP Buybacks and Liquidity Events

11. ESOPs vs. Other Incentive Plans

12. How to Implement ESOPs Effectively

13. The Future of ESOPs

14. Conclusion

15. Faqs

The Concept of Employee Ownership

When employees feel like owners, they think like owners. That’s the core philosophy behind ESOPs. By providing ownership through shares, companies encourage employees to contribute more strategically and stay loyal. It’s not just a paycheck anymore – it’s a stake in the business’s success. Similarly, modern fintech solutions like UPI - Payout enable seamless and instant distribution of payments, empowering companies to manage payroll and incentives efficiently.

How ESOPs Work

ESOPs typically follow a structured process:

• The company sets aside a pool of shares.
• Employees are granted options to purchase shares at a predetermined price (often lower than market value).
• Over time, employees “vest” — meaning they gradually earn the right to exercise these shares.
• Once vested, employees can either hold onto the shares or sell them, depending on company policies.

Types of ESOPs

• Non-leveraged ESOPs: Funded directly by the company.
• Leveraged ESOPs: Financed through loans that are repaid using company contributions.
• Stock Options vs. ESOPs: While similar, stock options are a right to purchase shares, whereas ESOPs often provide shares outright after vesting.

ESOPs in Startups

Startups often use ESOPs as a compensation strategy when cash is limited but potential is high.

It helps them attract skilled professionals who are motivated to grow with the company.

For example, Flipkart, Swiggy, and Zomato have made headlines with massive ESOP buyback programs — rewarding early employees with significant returns.

ESOPs in India

Under Section 62(1)(b) of the Companies Act, 2013, Indian companies can issue ESOPs to employees, directors, or officers. Listed companies must follow SEBI (Share-Based Employee Benefits and Sweat Equity) Regulations, 2021, while unlisted companies follow general provisions under the Companies Act. Companies can also leverage modern fintech solutions like UPI Autopay to automate recurring payments and streamline financial operations efficiently.

Advantages of ESOPs

For Employees

• Ownership mindset and motivation
• Wealth creation opportunities
• Sense of belonging and loyalty

For Employers

• Attract and retain skilled talent
• Reduce attrition rates
• Align employee performance with company goals

For Investors

• Boosts company valuation
• Encourages long-term growth
• Challenges and Risks of ESOPs

Challenges and Risks of ESOPs

• Valuation complexity: Determining fair share value can be tricky.
• Liquidity issues: Unlisted startups may not have easy exit routes.
• Awareness gap: Employees often don’t understand the real value of ESOPs.

How Companies Value ESOPs

The valuation of ESOPs depends on the Fair Market Value (FMV) of company shares. In India, a merchant banker usually conducts this valuation. Globally, the 409A valuation (especially in the U.S.) serves a similar purpose. Companies can also integrate efficient payment collection solutions to manage financial transactions and ensure smooth operations alongside ESOP management.

Taxation of ESOPs

Employees face taxation at two points:

• When exercising ESOPs, the difference between the market price and the exercise price is taxable as a perquisite.
• When selling shares, the profit is taxed as capital gains.
• To avoid double taxation, many companies structure ESOPs strategically.

ESOP Buybacks and Liquidity Events:

A buyback allows employees to sell vested shares back to the company at a fair value.

This creates a liquidity event — giving employees real financial benefit even before an IPO or acquisition.

Example: Zerodha and Razorpay have rewarded employees through massive ESOP buybacks in recent years.

ESOPs vs. Other Incentive Plans

How to Implement ESOPs Effectively

Step-by-Step Process

• Define eligibility and objectives.
• Allocate ESOP pool (usually 5–15% of company equity)
• Draft ESOP policy and obtain board approval.
• Get a valuation from a merchant banker
• Communicate the plan to employees clearly.
• Transparency and education are key — employees must understand the long-term value of their shares.

The Future of ESOPs

With the rise of fintech and equity management platforms, managing ESOPs is easier than ever. Digital tools help automate tracking, vesting, and taxation, empowering both employers and employees. Companies can also adopt modern Payment method solutions to streamline salary disbursements and other financial operations efficiently.

As startups continue to shape the economy, ESOPs will remain one of the most powerful tools for employee engagement and wealth creation.

Conclusion

ESOPs are not just financial perks- they are trust-building tools.

They connect employees emotionally and financially to the organization’s mission.

For startups and corporates alike, ESOPs are a bridge between contribution and reward — the perfect blend of loyalty and ownership.

FAQs

What is the main purpose of an ESOP?

To provide employees with ownership in the company, motivating them to contribute to its growth.

Are ESOPs taxable in India?

Yes, employees are taxed at the time of exercising the options and when selling the shares.

Can all employees get ESOPs?

Not always - ESOPs are typically granted to key employees or those with long-term service.

What happens to ESOPs if an employee resigns?

Unvested shares lapse, while vested ones may be exercisable within a specific period.

Why are ESOPs ideal for startups?

They help attract and retain talent when startups cannot offer high salaries initially.