Startup layoffs: why they happen and what the law says

Startups spend more than they earn while they grow, and the gap is filled by investor money. When investors become more cautious, as happened across India's startups in 2022 and 2023, the money stops arriving. A company then has to cut costs fast, and salaries are usually its biggest cost.

Four causes appear again and again. The company hired too fast when money was easy. A funding round fell through or was delayed. A product or market did not work as planned. Or the company merged with another and removed duplicate roles. Layoffs are not always a sign of failure, but a string of them can warn that the runway is short.

In everyday speech, all of these mean losing a job. In Indian labour law they differ. Retrenchment is the ending of an employee's service for any reason other than punishment, such as a cut in staff size. Termination for misconduct follows a disciplinary process. A resignation is the employee's own choice. The word lay-off in the law has a narrower meaning: a temporary inability to give work, for example due to a shortage of power or raw material, where the job is expected to resume.

Startups often call a permanent job cut a layoff, but legally it is usually a retrenchment. The label matters because the notice, pay and approval rules attach to it.

For workers covered by the Industrial Disputes Act, 1947, retrenchment needs one month's written notice or pay in place of notice, plus retrenchment compensation of 15 days' average pay for every completed year of service. Larger establishments faced extra conditions, including prior government permission above set headcounts. The Industrial Relations Code, 2020 brings these ideas into one law. Reports say it came into force on 21 November 2025, with the permission threshold raised to 300 workers, and the central rules following in 2026. Many state rules were still being finalised. Check the current text.

The Code also creates a re-skilling fund, to which the employer contributes 15 days' last drawn wages for every retrenched worker, which is paid into the worker's account.

Not every startup employee is a worker under these laws. The definition usually covers non-managerial and non-supervisory staff, and covers employees below a salary limit in the case of supervisors. Many software and managerial staff are outside it, and for them the terms of the employment contract, notice period and the state Shops and Establishments Act apply.

The basics come from the appointment letter. Most letters give a notice period of one to three months, or pay in place of notice. The company must pay all earned salary, unused leave that is encashable under the policy, and any bonus due, in a final settlement. Gratuity is payable after five years of continuous service, under the Payment of Gratuity Act. Provident fund belongs to the employee and can be withdrawn or transferred.

Many startups add severance beyond the legal minimum, often a few weeks of pay per year of service, along with extended health insurance for a short time. These are choices, not rights, but they have become common after public pressure.

Unvested options usually lapse on the last working day. Vested options stay, subject to the exercise window in the plan, which may be as short as 30 to 90 days. Some companies extend the window or accelerate vesting for laid-off staff. See the guides on vesting and on ESOP taxation to understand the cost of exercising.

Take these steps in the first week:

• Keep the termination letter, offer letter, payslips and any ESOP documents.
• Ask for the full and final settlement statement in writing, with dates.
• Check whether your role falls under labour law as a worker, or under your contract only.
• Confirm your PF account is active and update your UAN details.
• Read your ESOP exercise window and decide before it ends.
• Ask for a relieving letter and experience certificate.
• Note any promise of severance or insurance made in the email.

Founders should plan cuts once, deeply enough, instead of in several rounds that drain trust. Tell people directly, early and with clarity. Pay what is owed on time, provide fair severance if the cash allows, and help with references and job leads. Legal advice before acting is essential, because mistakes in notice and pay lead to disputes. This guide is general information, not legal advice, so consult a labour lawyer.