IPO: The coffee and the froth

What happens to your ESOPs when company goes IPO? If you have Rs. 1cr ESOPs will you be crorepati overnight? On paper yes, but there are lots of twists and turns and patience is the key. Let’s traverse an imaginary IPO journey. Before we proceed, there are few technical terms that we need to be aware of:

  • ESOPs: Employee Stock Option (notice the word option here, it is an option to buy a stock not actual stock)
  • Vesting date: The date on which any stock option becomes exercisable
  • Exercising period: The time window (typically 10 years from grant date) within which you must exercise the option, or they expire
  • Exercise date: The date on which you exercise the option, i.e. you convert the stock option to a stock
  • Exercise price: The price that you pay to convert stock option to stock. It is Rs. 1 in our company
  • FMV: Fair market value is the stock price as evaluated by some investment company
  • Perquisite: (FMV - Exercise price)
  • Sale date: The date on which you sell the stock

Important note on holding period: Your holding period for capital gains tax starts from the EXERCISE date, not grant or vesting date. For tax purposes:

Listed shares: >1 year = Long Term Capital Gains (LTCG), <1 year = Short Term Capital Gains (STCG) Unlisted shares: >2 years = LTCG, <2 years = STCG

Even before going for IPO there are lot of things that a company does. It files a DRHP (Draft Red Herring Prospectus) which is reviewed by SEBI. Company has to get its valuation done through some investment bank. Depending on this valuation, the IPO amount is decided. So, choosing a bank correctly is also of importance.

Anyway, let’s shift focus to employee side. As an employee, suppose your company is going for IPO in 6 months (say June 2026). If I have say 1000 vested shares of my company and they are valued at Rs. 2000. What happens when company goes for IPO?

Pre-IPO Exercise Scenario

First, you need to exercise your stock options. Say, you are exercising all 1000 options in May 2026 (before IPO). At Rs. 1 exercise price, you need to pay Rs. 1 × 1000 = Rs. 1,000 to exercise the options. Your perquisite amount becomes: Rs. 2000 - 1 = Rs. 1,999 per share. So, total perquisite amount becomes Rs. 19,99,000. This is taxable in your hand (as income from salary - perquisite) and tax needs to be paid as advance tax by the quarter-end. Since you’re exercising in May 2026 (Q1 of FY 2026-27), you need to pay advance tax by June 15, 2026. If you delay payment beyond this, interest penalties will start accumulating.

Important: Most established companies automatically deduct TDS (Tax Deducted at Source) on the ESOP perquisite when you exercise. This means the tax is handled by the company through payroll, included in your Form 16, and you don’t need to separately pay advance tax. However, some smaller companies may not do this, in which case you must pay advance tax yourself. Always check with your company’s HR/Finance team about their TDS policy before exercising.

Considering a 30% tax bracket, you need to pay approximately Rs. 6,24,000 as income tax (including cess).

Now, wait. You would say I haven’t got any money so how am I supposed to pay this tax? Well, that’s your challenge. You may manage it through savings, loan, or any other means, but you will have to pay this amount (or have it deducted as TDS) in the quarter that you exercise your option, irrespective of whether your stocks are giving you any money yet.

Seems unfair, but it is what it is. If you have crores of stocks and want to exercise all, you may have to pay crores in taxes even before getting any money in hand. So, be wise while exercising the options. Exercise them in batches as per your requirement and cash flow availability.

When company goes public (through IPO), there is a lock-in period of 6-12 months for employees. This lock-in period starts from the IPO listing date, not from your exercise date. So whether you exercised pre-IPO or post-IPO, the lock-in countdown begins from the IPO date. You can’t sell any stock during this period. Say, there is lock-in of 6 months from IPO date (June 2026), you won’t be able to sell any stock till January 2027. But you had exercised stocks in May 2026, so you will have to pay tax (or have TDS deducted) even though you won’t receive any money till January 2027.

Scenario 1: Stock price falls to Rs. 1000

What if the stock price falls to Rs. 1000 by the time your lock-in period is over? In this case, you get Rs. 1000 × 1000 = Rs. 10,00,000 by selling all the stocks. Since you bought at Rs. 2000 (FMV at exercise) and sold at Rs. 1000, you actually made a capital loss of Rs. 1000 per share = Rs. 10,00,000 total capital loss. Your net position:

Sale proceeds: Rs. 10,00,000

Minus exercise cost: Rs. 1,000

Minus perquisite tax paid: Rs. 6,24,000

Net gain: Rs. 3,75,000

The Rs. 10,00,000 capital loss can be carried forward for 8 years and set off against future capital gains (from stocks, property, gold, etc.). However, this capital loss cannot be set off against salary income - only against capital gains.

Scenario 2: Stock price falls below Rs. 600

Had the price fallen to Rs. 500, in that case you would have recovered only Rs. 500 × 1000 = Rs. 5,00,000 but you had paid tax of Rs. 6,24,000. So, you are net in loss of Rs. 1,24,000 (which government won’t repay you). This is your actual loss. But you can adjust the capital loss (Rs. 15,00,000 in this case: bought at Rs. 2000, sold at Rs. 500) against any capital gains in the next 8 years. Say, you sell some gold/property/shares and make some profit, you can deduct this loss amount from that profit while paying tax.

Scenario 3: Stock price rises to Rs. 3000

What if the stock price rises to Rs. 3000 by the time your lock-in period is over? In this case, you get Rs. 3000 × 1000 = Rs. 30,00,000. Essentially you made a profit of Rs. 3000 - 2000 = Rs. 1000 on each share (for capital gains calculation). So, you need to pay capital gains tax on this Rs. 1000 × 1000 = Rs. 10,00,000 gain. Since you exercised in May 2026 and selling in January 2027 (within 1 year), this is Short Term Capital Gains (STCG) for listed equity shares, taxed at 20%.

STCG tax = 20% of Rs. 10,00,000 = Rs. 2,00,000

Your net position:

Sale proceeds: Rs. 30,00,000

Minus exercise cost: Rs. 1,000

Minus perquisite tax: Rs. 6,24,000

Minus STCG tax: Rs. 2,00,000

Net gain: Rs. 21,75,000

If you had held for more than 1 year (Long Term), LTCG would be taxed at 12.5%, giving you Rs. 1,25,000 tax instead, and net gain of Rs. 22,50,000.

Post-IPO Exercise Scenario (Safer Strategy)

Now consider the case that you don’t exercise anything pre-IPO (assuming that your company allows it and your exercise period doesn’t expire). Once the lock-in period is over (say January 2027), you exercise stock options and sell them the same day or shortly after. Say, the stock price is Rs. 1000 on that day. In this case, when you exercise post-IPO, the actual market price on that day is considered for taxation, not the pre-IPO FMV value of Rs. 2000.

You pay Rs. 1 × 1000 = Rs. 1,000 to exercise the stock options.

Perquisite = (Market price - Exercise price) = Rs. 999 × 1000 = Rs. 9,99,000 becomes taxable as perquisite at your income tax slab. Tax @ 30% bracket (including cess): approximately Rs. 3,12,000

Now you sell it immediately at Rs. 1000 (same price as exercise), so your capital gain is zero. Therefore, STCG/LTCG tax is zero.

Your net position:

Sale proceeds: Rs. 10,00,000

Minus exercise cost: Rs. 1,000

Minus perquisite tax: Rs. 3,12,000

Net gain: Rs. 6,87,000

The major difference in this case is that you first get the money in hand and then pay tax out of it (or company deducts TDS from the sale proceeds). You have complete visibility of actual market price before making the exercise decision. So, post-IPO exercise scenario seems safer where you don’t have to take any risk before selling stocks. You get net approximately 68-70% of whatever you sell (given that your exercise period doesn’t expire by then and you’re in the 30% tax bracket). Note: The “net 70%” figure assumes a 30% tax bracket. This percentage varies based on your actual tax bracket:

30% bracket: ~68-70% net 20% bracket: ~79-80% net 5% bracket: ~95% net

Summary: Pre-IPO vs Post-IPO Exercise To sell pre-IPO or post-IPO is your choice totally. Following are the charges you will have to pay:

  • Exercising amount (paid while exercising the option - Rs. 1 per share in our case)
  • Perquisite tax (as per your income tax slab, paid as advance tax or through TDS in the quarter of exercise, irrespective of whether you have money from sale)
  • Capital gains tax (paid during the financial year when shares are sold, based on your holding period)

Whatever remains after this process is your profit.

Important Warnings and Tips

  • ESOP Expiry: Remember that ESOPs typically expire 10 years from grant date. If you don’t exercise within this window, you lose them entirely. Upon resignation, most companies give only 30-90 days to exercise vested options before they expire.
  • Company TDS Policy: Most established companies with ESOP programs automatically deduct TDS on perquisite. Startups might require you to handle it yourself. Always verify with HR before exercising to avoid tax compliance surprises.
  • Lock-in Period: The lock-in starts from IPO listing date, not from when you exercise. Whether you exercise 6 months before IPO or on IPO day, the lock-in countdown is the same.
  • Capital Loss Limitations: Capital losses can only be set off against capital gains, not against salary income. They can be carried forward for 8 years.
  • Batch Exercise Strategy: Don’t exercise all options at once if you don’t have sufficient cash reserves. Exercise in batches across financial years to manage tax liability and cash flow.
  • Documentation: Keep all records - grant letter, exercise confirmation, tax payment receipts/Form 16, sale confirmations. You’ll need these for ITR filing and future reference.
  • Professional Advice: For large ESOP holdings (₹50L+), consult a Chartered Accountant before exercising to optimize tax planning across financial years.

The Reality Check

If you notice, even after IPO, if the share price goes down drastically, you may not be in a good position to make substantial profit. The perquisite tax is calculated on FMV at exercise time, which is non-refundable even if the stock crashes later. The real wealth creation happens when:

  • You exercise at the right time (post-IPO after lock-in is safest)
  • The company continues to perform well post-IPO
  • Stock price appreciates significantly
  • You have the patience and cash flow to manage the tax implications

So, in turn, you have to work harder post-IPO to make the company successful, which in turn makes your remaining ESOPs more valuable. IPOs are not the finish line - they’re just the beginning of a new chapter where your efforts directly impact your wealth through stock price performance.