Beyond a Perk: Why ESOP Reform is the Make-or-Break Issue for India’s Startup Ambition

As India’s startup ecosystem celebrates its scale—over 200,000 DPIIT-recognized startups and 120+ unicorns—a critical structural flaw threatens its next phase of growth: the outdated and punitive framework governing Employee Stock Option Plans (ESOPs). What was once a symbolic perk has become the central battleground for talent, innovation, and long-term competitiveness. With a record IPO and exit wave creating real wealth, the ecosystem’s unified message to policymakers is clear: reforming ESOPs is no longer a request; it’s an urgent imperative for national economic strategy.

The push, led by industry bodies like Nasscom, IVCA, and the Startup Policy Forum, is driven by a stark reality. In the global race for deep-tech and AI supremacy, India’s greatest asset is its human capital. Yet, its current ESOP policies actively disadvantage the very engineers, scientists, and early employees who are building the country’s technological sovereignty.

The Core Conflict: Paying Tax on Paper Wealth

The most acute pain point is the taxation-at-exercise model. Unlike in the US where tax is deferred until the sale of shares (a liquidity event), Indian employees are taxed at the point they exercise their options—converting them to shares—based on the difference between the fair market value and the exercise price. This creates a catastrophic cash-flow problem:

• Paper Wealth, Real Tax Bill: An employee must pay tax on perceived “income” they have not yet realized, often forcing them to sell shares prematurely or borrow money, defeating the purpose of long-term ownership.
• The “Golden Handcuff” Becomes Shackles: Instead of incentivizing retention, it can force a talented employee to leave for a cash-rich competitor simply to pay their tax liability.
• Punishing Early Risk-Takers: The individuals who join a startup at its riskiest phase, accepting lower salaries for higher equity, are the ones most penalized by this rule when the company’s valuation rises.

The Talent Exodus: Competing on a Global Stage

India’s startups are no longer competing only with each other. They are vying for the same elite talent as global Big Tech firms and well-funded AI labs from Silicon Valley to Singapore. These competitors offer not just higher cash salaries but also transparent, tax-efficient equity packages. To attract and retain the architects of its AI future, India must offer a comparable equity proposition.

ESOPs are the single most powerful tool startups have to bridge the salary gap and create life-changing wealth for employees. Without reform, India risks a “brain drain 2.0,” where its best technical minds are financially incentivized to build for foreign giants rather than homegrown champions.

The Reform Agenda: A Three-Pillar Framework

The ecosystem’s demands, crystallized ahead of Union Budget 2026, are specific and actionable:

1. Deferral of Tax to Point of Sale: The paramount ask is to shift to a US-style 83(b) election model, where taxation occurs only upon the actual sale of shares, aligning the tax event with liquidity. This simple change would eliminate the cash-flow crisis and truly align employee and company fortunes.
2. Extension of Eligibility: The current beneficial tax deferment (Section 80IAC) is limited to DPIIT-recognized startups within 10 years of incorporation. Given that the path to IPO or acquisition is now longer, especially for capital-intensive deep-tech firms, there’s a strong push to extend this window to 15 years or remove the cap entirely for all startups.
3. Clarity on Secondary Liquidity & M&A: The ecosystem needs clear guidelines for ESOP treatment during secondary sales and mergers. Allowing the carry-forward of ESOP-related losses in acquisitions would make Indian startups more attractive acquisition targets and provide cleaner exit paths for employees.

The Ripple Effect: From Employee Wealth to Ecosystem Wealth

Effective ESOP reform would trigger a powerful virtuous cycle:

• Talent Retention & Attraction: Creates a compelling reason for top global and domestic talent to build their careers in Indian startups.
• Enhanced “Ownership” Culture: When employees are true, unencumbered owners, they drive innovation and accountability with greater intensity.
• Wealth Creation & Recycling: Successful exits create a new class of angel investors and repeat founders who have “skin in the game” experience, fueling the next generation of startups with both capital and wisdom.
• Ecosystem Maturity: Signals that India’s policy framework understands and supports the mechanics of building world-class, innovation-led companies.

Conclusion: A Defining Test of Political Will

The ESOP debate is a litmus test for India’s commitment to its own innovation agenda. It is a complex fiscal issue but one with a straightforward strategic implication: either we empower our builders to own a piece of what they create, or we watch them build for someone else.

As the ecosystem matures from chasing valuation to creating enduring value, its tools must mature with it. Reforming ESOPs is not about giving a tax break; it’s about installing the financial plumbing for a nation of owners and innovators. For India to truly become a global deep-tech leader, its most valuable stock must be in the hands of the people writing its code. The Union Budget 2026 presents a historic opportunity to make that happen.

Stay tuned to Startup Point for in-depth policy analysis and coverage of the Union Budget 2026’s impact on startups and innovation.