ESOP buybacks explained

An ESOP is an employee stock option plan: it gives staff the right to buy shares at a fixed price after they have vested, which means earned over time. Until a company lists on a stock exchange or is sold, these shares are hard to sell. An ESOP buyback fixes this. The company offers to buy back some of the shares employees hold, and pays them cash.

In a secondary sale, an outside buyer pays the seller. In a buyback, the company itself is the buyer, and the shares it buys are cancelled. This means the total number of shares falls, and every remaining shareholder owns a slightly larger share of the company. The cash comes out of the company's own funds, not from investors.

Staff at young companies often hold options worth a lot on paper but have no way to cash them. This can feel unfair, particularly for early employees who took lower pay. A buyback lets them realise some value, which helps with hiring and keeping people, and with paying the tax that falls due when options are exercised.

Several well-known Indian startups have run buybacks, and it became more talked about as companies stayed private for longer. Whether to run one is a choice for the board. A company with spare cash and profits may choose it. One that is burning cash usually cannot.

First the board and shareholders approve the plan. For a private company, the Companies Act, 2013 requires a special resolution in most cases, and there are limits on size. The offer is then made to eligible employees, with a price, a window and a cap on how many shares each person can sell. Employees who accept exercise their vested options if they have not already done so, and tender the shares. The company pays for them and cancels them.

The law sets limits on how much a company can buy back. As of October 2026, in general a buyback must be paid from free reserves, the securities premium account or the proceeds of a different share issue. It is capped at 25% of the paid-up capital and free reserves in a year, and the company's debt must stay within a ratio of 2:1 to its equity after the buyback. Some rules differ for specific types of ESOP-related buybacks, so the company's lawyers will check which apply.

There are usually two points of tax for an employee. The first is when options are exercised: the gap between the share's fair value on that day and the exercise price is taxed as a perquisite, a benefit of the job, like salary. Eligible DPIIT-recognised startups can defer that tax for a period, as set out in our ESOP taxation guide.

The second is when the shares are bought back. From October 2024 to March 2026, buyback proceeds were taxed in the shareholder's hands as a deemed dividend. The Budget of February 2026 moved this back to capital gains from 1 April 2026, so the shareholder is taxed only on the gain over the cost of the shares, with an additional tax on promoters. Rates depend on the type of share and how long it was held, and apply differently to each person, so confirm them before you act. Get advice from a chartered accountant before you sell.

The price is chosen by the company, usually based on a recent valuation by a registered valuer or on the latest funding round. It may be below the round price, because investors do not want the company to spend large sums on a price above its fair value. A lower price helps the company but may disappoint staff.

A buyback also affects the company's own numbers. The cash it spends is cash it cannot use for hiring, product or marketing, so early-stage companies with limited money often avoid it or keep it very small. More mature companies with steady cash flow can run it regularly, for example once a year, which makes staff more willing to hold options through the long wait for an IPO. For employees, the useful question is whether the company has a stated policy or only an occasional offer.

Investors need to agree too, because a buyback uses cash that could have funded the business, and their shareholders' agreement may require consent. This is why buybacks are often small and capped per person.

Before you sell, check the points below, and ask HR or the finance team for answers in writing.

• Who is eligible: only current staff, or former employees too?
• How many shares can each person sell, and is it first come first served?
• What is the price, and how was it set?
• What tax will be deducted and what will you owe yourself?
• Will there be another chance, or is this a one-off?
• Will selling affect your remaining options or your vesting?

A buyback is not a promise. It depends on the company having cash and the board agreeing. It rarely covers all of a person's holding, and it often has a cap per person. It also does not change the long-term path: the largest gains still usually come at an IPO or sale. Treat any buyback as a bonus, not as part of your plan. This guide is general information and not legal or tax advice.