What the ESOP grant letter doesn't tell you

Receive your ESOP grant, pocket the letter, move on. That is what most engineers do. The number looks meaningful: shares at a stated exercise price, multiplied by the latest valuation, comes out to something worth thinking about. So you think about it briefly, then file it away.

The number on the grant letter is the ceiling. What ends up in your account at exit depends on four things the letter almost never explains: the liquidation preference stack, the tax exposure at exercise, the fair market value at the moment you exercise, and what happens to your vested options if you leave. Any one of these can cut the headline number significantly. Together, they can reduce it to zero.

The number on your grant letter is a ceiling, not a promise

Your grant letter states: X shares at exercise price Y. The arithmetic from there is superficially simple: X shares times today's share price (derived from the last funding round) produces a figure that feels like your equity value. Most engineers stop there.

Options are not shares. They become shares only when you exercise them. And shares (particularly common shares held by employees) sit behind preferred shares held by investors in the payout queue at any exit. Before you count your proceeds from a hypothetical sale, you need to know how much investors are owed first.

The grant letter does not tell you that. The cap table does, and most employees do not have access to the cap table. What you can do is ask specific questions and know what the answers mean.

Liquidation preferences: who gets paid before you do

Every VC-backed Indian startup has a liquidation preference stack. Investors holding preferred shares get their investment back before common shareholders receive anything. Employees hold common shares or options that convert to common shares. They are at the back.

A 1x non-participating preference is the standard structure at early stages. Suppose a startup raised Rs 100 crore from investors across rounds, with a 1x non-participating preference. The company sells for Rs 150 crore.

• Investors take Rs 100 crore first.
• The remaining Rs 50 crore splits by equity ownership.
• If employees collectively hold 15% of the cap table, they share Rs 7.5 crore, which sounds like something, but is roughly 5% of the total exit.

If the company sells for Rs 80 crore:

• Investors take Rs 80 crore.
• Employees: nothing.
• The company had a successful exit. Someone paid real money for it. Every employee on the common side walks away empty-handed.

Participating preferences (common at later funding rounds) are more aggressive. They let investors take their preference and then participate in the remaining pool as equity holders. This compresses what is available to employees further.

This information is not secret. Ask your CFO or finance team: 'What is the aggregate liquidation preference on the cap table, and is any of it participating?' They may not share the full cap table, but the question is reasonable and the answer is telling. If they will not answer at all, treat that as data.

The tax-before-you-see-money problem

India taxes ESOPs at two separate points: exercise and sale. Most employees understand the second. Few are clear on the first.

At exercise, the spread between the FMV on the exercise date and your exercise price is treated as perquisite income, taxed at your income slab rate, with TDS deducted by your employer. At the 30% bracket, a Rs 20 lakh spread costs you Rs 6 lakh in income tax on the day you exercise. The shares remain private and illiquid.

At sale (the eventual IPO or secondary transaction), the gain from FMV on exercise date to your sale price is taxed as capital gains: short-term if held less than 24 months, long-term if held longer. Capital gains rates are more favourable than income slab rates.

The problem is that the income tax lands before you have liquidity. If the company's valuation compresses between your exercise date and the eventual exit, you have paid income tax on a spread that has since shrunk or disappeared. You cannot reclaim it. The capital gains tax on sale will be zero or negative, but a negative capital gain does not offset the income tax you already paid.

FMV is not your company's latest funding valuation

Fair Market Value is set by a SEBI-registered merchant banker, commissioned and paid for by the company. It must be prepared within 180 days of the exercise or grant date. You do not get to choose the methodology or the valuer.

FMV affects two things: the exercise price on new grants, and the income tax you owe when you exercise. A high FMV raises both.

Startup valuations are partly driven by investor expectations rather than current earnings. A company that raised at 40x revenue will carry a high FMV even if its trajectory has slowed since that round. Exercising options when FMV is near its peak (say, immediately after a large funding round) generates a large tax bill on a number that may compress over the following two years.

The valuation methodology matters and employees rarely see it. Valuers use either the discounted cash flow method or market comparables. Optimistic projections can produce a high FMV. There is no obligation to share the detailed methodology with employees, but you can ask for the headline FMV figure and the date it was prepared. Knowing when the last valuation was done tells you something about its currency.

What happens to your options when you leave

When you leave the company, unvested options lapse immediately. That is standard and expected.

What surprises engineers is that vested options also come with a departure clock. Once you leave, you have a defined window to exercise them before they expire. If you do not exercise in that window, the options are gone.

The standard window in India is 90 days. That is enough time to arrange cash, model the tax implications, and make a considered decision. But 90 days is not mandated by law. It is convention. Companies can set any window they choose.

In late 2025, Unacademy reduced their post-departure exercise window to 30 days for departing employees. This meant engineers who were laid off had one month to source the cash for exercise plus the immediate income tax liability, or walk away from years of vesting. For anyone who had not mentally prepared for this, 30 days is effectively no window at all.

Buybacks: real liquidity, taxed as salary

Several large Indian startups run periodic ESOP buyback programmes, offering employees a chance to sell a portion of their vested options at a company-determined price. More than Rs 1,409 crore was distributed through buybacks across over 9,200 employees in 2025, according to Inc42's reporting. Buybacks have become the primary liquidity mechanism in an environment where IPOs are years away for most growth-stage companies.

The common misconception is that buyback gains are taxed at capital gains rates.

They are not. In most buyback structures, the gain is treated as perquisite income, taxed at your income slab rate. At 30%, a Rs 10 lakh buyback gain nets Rs 7 lakh. Under long-term capital gains, the same gain nets around Rs 8.8 lakh at the 20% rate. The difference is not negligible at meaningful grant sizes.

This does not make buybacks a bad deal. It makes them different from what most people assume when they are offered the option.

Double-trigger acceleration: common in US contracts, rare in India

If your startup is acquired, your unvested options do not automatically vest. You are expected to continue working for the acquirer for the remainder of your vesting schedule. If the acquirer offers a retention package that does not fully replace the unvested equity value, you are effectively subsidising the acquisition deal with future compensation you already earned.

Double-trigger acceleration prevents this. First trigger: the company is acquired. Second trigger: your role is subsequently terminated or substantially changed. Both must occur for unvested options to vest immediately.

This provision is standard in US tech employment at senior levels. In Indian startup contracts, it is uncommon. Most founders do not include it because it adds complexity to acquisition negotiations. Acquirers price in the cost of unvested equity they will need to honour if they terminate people post-close, and provisions that accelerate that cost make deals harder to structure.

If you are negotiating a senior role, it is worth asking whether double-trigger acceleration is on offer. At mid-level IC roles, you are unlikely to get it. But knowing the provision exists helps you understand the risk profile of your unvested equity in any acquisition scenario.

Three questions to ask before you sign or exercise

These three questions cover the most consequential unknowns. The answers will not always be satisfying, but asking them on record is useful regardless.

One: 'What is the aggregate liquidation preference on the cap table, and is any of it participating?'

You want two numbers: the total amount investors are owed before common shareholders receive anything, and whether any investors have participating preferences on top. Compare the aggregate preference to the company's realistic exit range. If the company would need a 3x exit on total capital raised for employees to receive anything material, that threshold matters to how you think about your equity.

Two: 'What is the exercise window if I leave?'

This should be in your grant letter. If it is 90 days, that is the standard. If it is 30 days, model what it would cost to exercise within that window: the exercise price plus estimated income tax at your slab rate. If that total exceeds what you can access in a month without notice, your vested equity may be practically unreachable in a sudden departure scenario.

Three: 'Is the company DPIIT-registered, and does the tax deferral apply to my grant?'

If yes, you can defer the perquisite income tax until you have liquidity. If no, model the income tax liability before you exercise, particularly if the FMV spread is large. Exercising and immediately owing more in income tax than you had planned for is a situation that catches people off-guard.

The grant letter is a starting point. The questions above fill in the structure around it. None of this requires legal expertise. It requires knowing what to ask.