5.10Equity, ESOPs and compensation

ESOP buybacks and liquidity programmes

Stage: SeedCore

1. The core idea#

Options in a private company are only worth something if, one day, they can become cash. For most of a startup's life that day is far away: deeptech companies often take 8–12 years to reach an IPO or a large acquisition. Liquidity programmes close part of that gap. They let current and former employees sell some of their shares, or option-backed shares, before an exit.

The main forms:

  • Company buyback: the company uses its own cash to buy shares from employees (after they exercise), usually at or near the latest round's price.
  • Secondary sale or tender offer: an investor, often the lead of a new round or a secondary fund, buys shares from employees and early holders. The company organises it but doesn't pay.
  • Cash settlement of options: the company pays the gain on vested options in cash, cancelling them, without employees ever exercising.
  • Sale of the company or IPO: the eventual full liquidity event (5.20 covers founder secondaries).

Done well, a liquidity programme is a powerful retention and recruiting tool: it proves equity is real, lets people pay tax on exercises, and rewards long-serving staff. Done badly, it signals that the founders don't expect an exit soon, uses cash the company needs, or creates tax and securities problems.

For most startups the first programme comes around Series B or later. But planning starts earlier: the option plan, SHA and articles must allow buybacks and transfers, and leaver policies should anticipate them (5.09).

Who this is for: founders at Series A and beyond planning first liquidity; anyone negotiating a round where the lead offers to buy employee shares; Indian founders considering an ESOP buyback.

Pairs with: 5.08 (tax), 5.09 (leavers), 5.20 (founder secondaries), 4.19 (FEMA for crossborder buyers).

2. What the evidence says#

India: buybacks are back in 2026. Entrackr counted about $220 million of Indian startup ESOP buybacks in the first quarter of 2026 alone, more than in all of 2024 or 2025, led by BrowserStack's $125 million programme for about 500 employees and Innovaccer's buyback; cumulative startup ESOP repurchases since 2020 approach $2 billion. By Inc42's count, 12 Indian startups ran ESOP buybacks in 2025 for more than 9,200 employees, worth ₹1,409 crore (about $158 million), against 23 startups and about ₹1,448 crore in 2024. Entrackr's series puts total ESOP buybacks, payouts and liquidity at around $190 million in 2024, $802 million in 2023, $200 million in 2022 and $440 million in 2021, so activity swings with funding cycles.

US: tender offers at record levels. Carta administered 71 tender offers worth about $3 billion in the first half of 2026, the highest first-half figures in at least six years. A record 16,538 employees sold equity in tender offers on Carta in 2025, and about 20% of them were former employees. Nearly 70% of H1 2026 tenders were at companies at Series C or later.

How programmes are structured (Carta data).

  • Caps: in the median company buyback, eligible employees can sell up to 25% of their shares; in secondary sales to outside buyers, the median cap is 20% for both employees and ex-employees.
  • Ex-employees: in the median company-run buyback, ex-employees are not eligible at all; secondary sales are more often open to them.
  • Pricing: the median tender within a year of the last priced round has had no discount to that round's price; discounts are currently uncommon.

India's tax rules changed again. Buyback proceeds were taxed as dividends in shareholders' hands from 1 October 2024 to 31 March 2026. The Finance Act 2026 moved them back to capital gains from 1 April 2026, so sellers now pay tax only on the gain over their cost (for exercised ESOP shares, the FMV at exercise). Promoters pay an additional tax on top, taking them to an effective rate of about 30% (22% for promoter companies). For ordinary employees this is clearly better than the dividend regime.

3. The method: designing a programme#

Step 1: Decide whether it's the right time#

Good reasons: many long-serving employees with significant vested equity; a new round with investors keen to buy more; a long expected time to exit; retention risk among key people. Warning signs: cash needed for R&D or manufacturing; a buyback that would leave less than 18–24 months of runway; a valuation that is hard to justify.

Step 2: Choose the structure#

Structure Who Pros Cons
pays
Company buyback Company Simple; company controls
price and timing		 Uses company cash; legal
limits on buybacks
Secondary to new or
existing investors		 Investors No company cash;
investors get more of the
company		 Investors may want a
discount or preferred
rights; more parties
Combined with a
primary round		 Investors Efficient; one valuation Complex documents; may
affect 409A
Cash settlement of
vested options		 Company No exercise needed;
simple for employees		 Taxed as salary; uses cash;
no shares issued

Step 3: Set the terms#

  • Eligibility: current employees with a minimum tenure (often 2+ years); decide deliberately about former employees.
  • Cap: a percentage of each person's vested holding (20–25% is median), and an overall cap on the programme.
  • Price: at or near the last round's price; avoid buying above fair value from employees in a company buyback, because the excess can be taxed as compensation in the US. Exercise and sale together: let option holders exercise and sell in one step, with tax withheld from proceeds.
  • Timing: one window a year or at each priced round, announced in advance, open for at least 20 business days if US tender offer rules may apply.

Board and shareholder approvals; disclosure document explaining price, company position and risks; tax computation and withholding; filings (section 4). Give every eligible person the same information.

Step 5: Communicate well#

Explain why the programme exists, how the price was set, that selling is optional, and that the company is not signalling a delayed exit. Offer access to tax advisers.

Worked example#

A Bengaluru robotics company with a Delaware parent raises a $40 million Series B at $6.00 per preferred share. 120 employees hold vested options; 35 have been there more than three years.

  1. Structure: the lead investor agrees to buy up to $4 million of common shares from employees as part of the round, at $5.40 (10% below preferred), plus the company sets aside $1 million for a parent-level buyback for ex-employees.
  1. Terms: employees with 2+ years' tenure may sell up to 25% of vested holdings; exemployees who left as good leavers may sell up to 20%. Exercise and sale happen together.
  2. Tax: for Indian employees, the perquisite at exercise is the merchant banker FMV minus strike, taxed as salary with TDS deducted by the Indian subsidiary from proceeds; the sale gain is then near zero. For US employees, the sale is reported; the 10% discount to preferred keeps it close to fair value.
  3. Cross-border: Indian residents selling parent shares to a US investor report the disposal of overseas investment through their bank; the Indian subsidiary reports the ESOP transactions (4.19).
  4. Result: 68 people sell $3.6 million in total; the 409A appraiser treats the secondary price as one data point among several, and the next common stock valuation rises modestly.

4. Country mechanics: India, US, UK#

India: company buybacks under Companies Act s.68.

  • Authority: the articles must permit buybacks.
  • Size: up to 10% of paid-up capital and free reserves with a board resolution; up to 25% with a shareholders' special resolution; only one buyback in any 12 months.
  • Funding: from free reserves, securities premium or the proceeds of a different fresh issue. After the buyback, debt must not exceed twice paid-up capital and free reserves.
  • Process for private companies: letter of offer to all shareholders of the class (or a buyback limited to employees under an ESOP scheme, as permitted), a declaration of solvency (Form SH-9), completion within a year of the resolution, extinguishing the shares within seven days, and a return of buyback (SH-11) within 30 days. The company cannot issue shares of the same kind for six months afterwards, except bonus issues and conversions such as ESOP exercises.
  • Alternatives: many Indian startups provide liquidity through a secondary sale to an investor, or through an ESOP trust that buys shares from employees and holds them for future grants, avoiding the s.68 limits.
  • Tax: from 1 April 2026, buyback proceeds are capital gains for shareholders (promoters pay an additional tax). For ESOP shares, the gain is measured from the FMV used at exercise.
  • FEMA: sales by Indian residents to foreign investors must be at or above fair value and reported in Form FC-TRS within 60 days (4.19).

US.

  • Tender offer rules: a broad offer to many holders can be a "tender offer" under Regulation 14E even for a private company: it must stay open at least 20 business days, with specific disclosure.
  • Compensation risk: if the company (or an investor acting for it) pays employees more than fair value, the excess can be treated as compensation, taxed as ordinary income and potentially affecting ISOs. Price at or below the latest preferred price, and document why.
  • 409A: secondary prices feed into the next 409A. Small, discounted, non-recurring sales usually carry less weight.
  • ISOs: selling ISO shares within one year of exercise or two years of grant is a disqualifying disposition, taxed as ordinary income.
  • Right of first refusal: most bylaws or SHAs give the company a ROFR over transfers; the programme must waive or use it.

UK.

  • Purchase of own shares under the Companies Act 2006 needs distributable reserves (or a permitted capital payment), shareholder approval of the contract, and filings; stamp duty of 0.5% applies.
  • Tax: the payment above the original subscription price is usually taxed as an income distribution, unless the conditions for capital treatment are met (including a minimum holding period, normally five years, and a substantial reduction in the seller's stake). Many UK startups therefore prefer employee benefit trusts or secondary sales to investors, which are taxed as capital gains.
  • EMI shares sold in a secondary sale keep their CGT treatment, with BADR if conditions are met.

Scripts#

Announcing a programme:

"As part of our Series [x], we're giving everyone who has been here two years or more the chance to sell up to 25% of their vested shares at [price], which is [discount] below our new round's price. Selling is entirely optional. We're doing this because many of you have built the company for years, not because we expect a sale soon. Information sessions and tax guidance are on [date]."

Asking a lead investor to fund a secondary:

"Alongside the primary, we'd like to offer our long-serving team some liquidity. Would you consider buying up to [amount] of common from employees at [price]? It increases your ownership, and it helps us keep the people who built the technology."

Explaining to an employee why they might not sell everything:

"This is a chance to take some money off the table and pay any tax on your exercise. Many people sell enough to cover their tax and keep the rest for the long-term upside. It's your choice; we'd suggest talking to an adviser."

Common mistakes#

  1. Buying back too early, using cash the company needs.
  2. No articles or SHA authority for buybacks or transfers.
  3. Ignoring India's s.68 limits or the six-month restriction on new issues.
  4. Paying above fair value in a company buyback, creating compensation income in the US.
  5. Excluding former employees without explaining why.
  6. Not withholding tax on exercises that happen at the same time.
  7. Forgetting FEMA filings for cross-border secondary sales.
  8. Applying old tax rules: Indian buyback taxation changed in October 2024 and again in April 2026.
  9. Poor communication, so employees read the programme as a signal that the founders are cashing out.
  • 3.12 Co-founder breakups: buybacks and good/bad leaver terms
  • 4.19 FEMA, FDI and ODI rules for foreign money
  • 5.07 Setting the strike price: US 409A and Indian valuations by a merchant banker
  • 5.08 ESOP tax: Indian perquisite tax and the deferral for DPIIT startups; US ISO and AMT
  • 5.09 Exercise windows and what happens when people leave
  • 5.20 Founder secondary sales

Sources#

← 5.09 Exercise windows and what happens when people leave5.11 Explaining equity to employees: offer letters and equity education →