How to run an ESOP buyback or secondary transaction

Most Indian SME ESOPs are illiquid — there's no market to sell the shares, and the only exit event is a fundraise, an acquisition, or an IPO. This illiquidity undermines the retention value of ESOPs for employees who need liquidity. A structured ESOP buyback or secondary transaction can address this.

ESOP buyback: the company repurchases shares from employees who have exercised their options. This provides liquidity to employees and is a strong retention and motivation signal. Legal structure: a buyback under Section 68 of the Companies Act 2013 must follow prescribed conditions — the buyback cannot exceed 25% of paid-up equity, must be funded from free reserves or the securities premium account, and requires a special resolution of shareholders. The buyback price should be at FMV and should be uniform for all selling shareholders.

Secondary sale: instead of the company buying back shares, employees sell to a secondary investor (a fund, a strategic investor, or an ESOP trust) at a negotiated price. This requires finding a willing buyer and agreeing on a price and process. ESOP-focused funds and secondary investors exist in India specifically for this purpose.

Tender offer process: in a structured ESOP liquidity event, the company announces a tender offer — inviting all option holders and shareholders to offer their shares for sale at a fixed price. This is the most orderly and legally compliant mechanism for large-scale ESOP liquidity events.

Tax at buyback: when shares are bought back by the company, the company pays buyback tax (20% of the distributed amount plus surcharge and cess) and the gain is exempt in the hands of the shareholder (as amended from 2024 onwards — check current provisions with your CA). For secondary sales, capital gains tax applies in the hands of the selling employee.

PF/ESIC (CONTINUED)