The hidden cost of Esops and what startup employees miss

But this was Gupta’s third Esop liquidity event. The first two barely moved the needle. In the third case, the timing aligned. “I would say I got lucky. During that period, the large cab-hailing companies were acquiring smaller companies, and my company was one of them," he recalled. “The payout helped me buy my first house in Hyderabad without a loan and start my venture, ServiceGTD."

It also taught Gupta a lesson many discover too late: Employee stock option plans or Esops can be transformative, but only with the right timing and clarity.

Recent IPOs like Groww, Lenskart, and Urban Company have brought Esops back into focus. Stories of employees becoming millionaires circulate widely, but beneath them lies a quieter reality: far more employees never see the payout they expect.

Abhishek Goel, a product management leader in Bengaluru, has lived that harder reality. He has held Esops of one company that went public and a large pool of such stock options at another.

“Returns from the IPO were almost zero due to high exercise costs. Grants at the second company are life-changing, but I’ve left the company. Most employees leaving before an IPO miss out due to short exercise windows and post-IPO lock-ins."

Goel added that many Indian startups make it difficult for employees to realise Esops, unlike in mature markets. “In the US, Dubai or Europe, stock option terms are usually clearer and more employee-friendly."

The fine print of Esops

When a company offers Esops, it doesn’t give you shares upfront. It gives you the right to buy them later at a discounted price. There are two stages in the process: vesting and exercise.

Let’s understand with an example. Say Mr A is offered 1,000 shares at a discounted price of ₹100 per share, while the fair market value is ₹200, with a vesting period of two years. Vesting means he earns the right to buy the shares only after those two years; if he resigns before that, he loses them. Once vested, the exercise period opens, which is the window during which he will need to pay ₹1 lakh (1,000 shares multiply ₹100) to own the shares.

At this stage, most employees stumble, as there’s a hefty tax bill to be paid as well. The difference between the exercise price and the fair market value (FMV) on the exercise date is treated as a perquisite and taxed at the applicable slab rates.

In the above example, say the FMV of shares has jumped to ₹1,000 per share at the time of exercising. For 1,000 shares, the total FMV is ₹10 lakh. Mr A has to pay 30% tax (surcharge and cess extra) on ₹9 lakh ( ₹10 lakh minus ₹1 lakh exercise price) as perquisite tax. Therefore, Mr A must now pay ₹2.7 lakh in tax and ₹1 lakh as the exercise price upfront just to own the shares, but without any guarantee of liquidity.

Mahesh Kumar, an engineering leader, has learned this the hard way. His exercise price was almost zero at grant, but by the time he exercised the option, the FMV had soared 5X to over ₹1 lakh per share. “That difference was taxed at about 37% (including surcharge and cess). I paid tax on almost the full value long before I could sell a single share," he said.

Exercising feels risky

For these reasons, most employees delay exercising their options unless a liquidity event is imminent. However, while current employees often have no deadline to exercise the option, ex-employees don’t have that luxury. After leaving the company, they usually get a small window, making it an even bigger risk as the stock options could remain illiquid for a long time.

Goel also faced this dilemma. “My exercise cost alone was 37% of the listing price, plus 33% tax on the difference. Then there was a one-year lock-in, and by the time it ended, the stock had fallen. I made some profit, but only 20–30% of what I had expected after years of waiting."

Kumar fears a similar outcome. “Value of my stock options has been stagnant for two years despite company growth. After heavy taxes, if the share price doesn’t rise, real returns could be minimal or even negative once you factor in opportunity cost."

Kumar compared this with his restricted stock units (RSUs) at the current employer, and the difference got starker. By contrast, once RSUs vest, the employer deducts TDS on the perquisite, credits the remaining shares to the employee’s demat account, and there’s no massive cash outflow.

Know what you are offered

Esops often come with riders that can dilute a significant portion of the stock originally promised. The most common is the short exercise window after leaving the company, typically three months to two years, which can make exercising impossible and force employees to forfeit years of earned stock.

“You have to pay the full exercise cost and tax from your pocket in such a short time. Most people simply can’t, so the shares are rescinded," said Goel.

Companies further tighten liquidity for employees after they leave in other ways, too. Kumar, for instance, missed a recent buyback by a previous employer as it was open only to current employees.

Complex vesting clauses can further reduce options. “In some cases, vesting is linked to individual or company KPI (key performance indicator), key milestones and corporate actions, which can be quite confusing and leave many employees at a disadvantage," said Bharath Reddy, partner at Cyril Amarchand Mangaldas.

For example, if 100 shares are due this year, and the company's rating is three out of five, you can vest only 60 shares. Further, if your individual rating too is three out of five, you finally vest only 36 shares, while 64 are clawed back.

Similarly, many companies follow a back-loaded multi-year vesting schedule where a larger chunk of the stock options vest in the later years of the vesting period, rather than in equal annual instalments. This structure ties the employee to the company, or they can exit and say goodbye to their stock options.

Reddy advises employees to review the grant letter and Esop plan carefully before accepting an offer. “This ensures that the terms being promised can actually be provided."

How much Esops should make up your CTC

The value of employee equity is determined by the fate of the company. The stock options may be illiquid for a long time or ultimately worth nothing, while taxes and the costs of exercise, may not be recouped. So, a prudent approach is to treat Esops as a bonus, not a guaranteed payout.

Anjali Raghuvanshi, chief people officer, Randstad India & GCC, senior director - business innovation, said for early to mid-career talent, Esops should not exceed 10% to 15% of the total package. “At the leadership or CXO level, where risk appetite is higher, equity going to 30% or 40% may make financial sense," she said.

Bengaluru-based Deepti K.S., a people business partner, once accepted a role where Esops formed 70% of her CTC, which she couldn't exercise. In the next company, she ensured the Esop value was over and above the compensation structure.

“I reduced the Esop component the second time, given my decreased confidence in their liquidation," she said. Today, she calls it a lottery system. “I consider Esops speculative and long-term. One also needs to be lucky to see a liquidation event in their lifetime just like how employees at Flipkart, Swiggy, Zomato or Ola did."

To meaningfully benefit from Esops, look for employee-friendly conditions like short cliff periods, long exercise windows, straightforward vesting etc. The most critical clause to consider is the exercise window post-separation, as per Raghuvanshi. “Employees should look for companies offering 'cashless' exercise options or extended windows of two to five years."

A longer exercise window allows former employees to wait to exercise their stock options until an IPO. Reddy said for liquidation through an IPO, there is a ready market for the shares and various funding options, such as Esop financing programs, to help employees cover the exercise cost and tax outflow and manage cash flow. “Employees can then sell their shares immediately after exercising," he said.

Esops can transform wealth, but they come with complex conditions and significant risks. Treat them as a bonus, not guaranteed income, and prioritise clear, employee-friendly terms. Kumar and Goel now prefer a cash salary or RSUs over Esops, unless the terms are clear.