The recent public listings of companies like Groww, Lenskart, and Urban Company have once again shone a spotlight on Employee Stock Option Plans (Esops), fueling dreams of overnight wealth for startup employees. However, behind the celebrated stories of millionaire employees lies a less glamorous truth: for many, the promised Esop payout never materializes due to complex terms, hefty tax bills, and ill-timed exits.
The Dream vs. The Reality of Esop Payouts
Navneet Gupta's story represents the Esop dream realized. After leaving his employer in 2020, an early employee grant, amplified by a sectoral boom and acquisitions in cab-hailing, resulted in a life-changing payout. "The payout helped me buy my first house in Hyderabad without a loan and start my venture, ServiceGTD," Gupta recalled. He acknowledges, however, that this was his third liquidity event, with the first two being insignificant, underscoring the critical role of timing.
For product management leader Abhishek Goel in Bengaluru, the experience has been starkly different. He held Esops in a company that went public, but the returns were "almost zero due to high exercise costs." While grants at another company are potentially transformative, leaving before an IPO often means missing out due to restrictive exercise windows and post-IPO lock-ins. Goel points out that terms in India are often less employee-friendly compared to mature markets like the US or Europe.
Decoding the Fine Print: Vesting, Exercise, and the Tax Trap
It's crucial to understand that Esops are not free shares. A company grants the right to purchase shares at a pre-set discounted price in the future. This process involves two key stages: vesting and exercise.
Vesting is the period over which an employee earns the right to buy the shares. If they leave before this period ends, they typically forfeit the options. Once vested, the employee enters the exercise window, where they must pay the pre-determined price to actually own the shares.
This is where the first major hurdle appears: a significant tax liability. 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 employee's income tax slab rate.
Consider this example: An employee is granted 1,000 shares at an exercise price of ₹100 (FMV at grant: ₹200). After two years, when they exercise, the FMV has jumped to ₹1,000 per share. They must pay ₹1 lakh to buy the shares. However, the perquisite value is ₹9 lakh (₹10 lakh total FMV minus ₹1 lakh cost). This ₹9 lakh is added to their income and taxed, say at 30%, leading to an immediate tax outgo of ₹2.7 lakh, plus the ₹1 lakh exercise cost—all without any guarantee of being able to sell the shares immediately.
Engineering leader Mahesh Kumar experienced this firsthand. His exercise price was nearly zero, but the FMV at exercise had soared. "I paid tax on almost the full value long before I could sell a single share," he said, highlighting the cash flow strain and risk.
Why Exercising Feels Like a Gamble
Due to this substantial upfront cost and tax, most employees delay exercising unless a liquidity event like an IPO or acquisition is imminent. While current employees may have no deadline, former employees face a critical constraint.
Upon leaving a company, ex-employees usually get a short window—often just 90 days to two years—to exercise their vested options. This forces a high-stakes decision: pay large sums for potentially illiquid assets or forfeit them entirely. Abhishek Goel's experience was sobering: high exercise costs and taxes, followed by a lock-in period and a subsequent fall in share price, resulted in profits that were only 20-30% of his original expectation.
Kumar now prefers Restricted Stock Units (RSUs), where shares are credited after vesting with taxes deducted at source, requiring no large cash outflow from the employee.
Key Clauses Employees Must Scrutinize
Experts advise employees to look beyond the headline grant number and examine the Esop plan document carefully. Key pitfalls include:
- Short Post-Separation Exercise Window: The most critical clause, according to HR leaders. A window of just a few months can make it financially impossible for a departing employee to exercise their options.
- Complex Vesting Schedules: Some plans link vesting to individual or company performance KPIs, or use back-loaded schedules where a larger chunk vests in later years, effectively tying the employee to the company.
- Exclusion from Liquidity Events: Companies may restrict participation in buybacks or tender offers to current employees only, leaving former staff with illiquid shares.
Bharath Reddy, partner at Cyril Amarchand Mangaldas, stresses reviewing the grant letter to ensure the promised terms are actually deliverable.
A Prudent Approach: Treat Esops as a Bonus, Not Salary
Given the inherent illiquidity and risk, a prudent strategy is to view Esop value as a potential bonus, not as guaranteed compensation. Anjali Raghuvanshi, Chief People Officer at Randstad India, suggests that for early to mid-career professionals, Esops should not exceed 10% to 15% of the total compensation package. At leadership levels, where risk appetite is higher, it may constitute 30-40%.
Deepti K.S., a people business partner in Bengaluru, learned this lesson after accepting a role where Esops formed 70% of her CTC—value she couldn't realize. In her next role, she negotiated for Esops to be an addition to her base salary. She now views them as speculative, akin to a "lottery system," requiring luck for a liquidation event to occur during one's tenure.
To truly benefit, employees should seek companies with employee-friendly terms: longer exercise windows post-separation (2-5 years), cashless exercise options, simple vesting schedules, and access to Esop financing programs during IPOs to manage the cash flow crunch.
While Esops hold the power to create transformative wealth, as seen with early employees of Flipkart or Zomato, they are fraught with complexity. For every success story, many more face forfeiture, heavy taxation, and minimal returns. The key takeaway is to prioritize clear terms, understand the financial commitment, and never bank your present financial stability on an uncertain future payout.
