Rich on paper, broke in the bank
Six years in, the founder's shareholding is worth crores on the last round's valuation. His bank balance is not. He has taken a below-market salary the whole way, the company is not going to IPO for years, and his shares are locked inside a private company that pays no dividend. This is the quiet problem nobody warns first-time founders about: equity is wealth you cannot spend, and until there is an exit it stays that way. The answer is a liquidity event — a way for founders and early employees to convert some of that paper into cash without waiting for the whole company to be sold or listed. There are two clean ways to do it: the company can buy your shares back, or you can sell them to someone else in a secondary. Both got materially more complicated in tax terms from October 2024, and getting the route and the pricing wrong turns a life-changing payday into a tax notice. Here is how founder and employee liquidity actually works in India, and what changed.
What "liquidity" means before an exit
Almost everything else on a startup's cap table is about issuing new shares — a funding round, an ESOP pool, a fresh allotment — which brings money into the company and dilutes everyone. A liquidity event is the opposite. No new shares are created; existing shares change hands or are cancelled, and the money goes to the person selling, not into the company's bank account. That single difference — cash to the shareholder, not to the company — is what makes it "taking money off the table". It usually happens in one of two ways. In a buyback, the company itself purchases shares from its shareholders and extinguishes them. In a secondary sale, a shareholder sells their shares to another buyer — an incoming investor, an existing one topping up, or the founders themselves. The company's own share count and cash are untouched in a secondary; only the register of members changes. Which route fits depends on who has the cash to pay you and what the tax looks like on each side, and since October 2024 those two questions have very different answers than they used to.
Route one: the company buys your shares back (Section 68)
A buyback is governed by Sections 68 to 70 of the Companies Act, 2013, and it is not a free-for-all — the company can only return so much capital to shareholders, and only from the right pockets. A company may buy back its shares out of its free reserves, its securities premium account, or the proceeds of a fresh issue, and the size is capped: in any financial year a buyback cannot exceed 25% of the paid-up equity capital, and the aggregate cannot exceed 25% of paid-up capital plus free reserves. After the buyback the company's total debt must not be more than twice its paid-up capital and free reserves (the 2:1 rule), only fully paid-up shares can be bought, and the whole thing must be completed within one year of the authorising resolution. A buyback of up to 10% of paid-up equity capital and free reserves can be authorised by a simple board resolution; anything above that, up to the 25% ceiling, needs a special resolution of the shareholders. There is also a cooling-off period — a company generally cannot launch another buyback within a year of the last one. The practical takeaway for a founder: a buyback is a real, board-and-registrar process with hard limits, not something you arrange on a phone call, and it only works when the company has the reserves to fund it.
The 2024 change that flipped buyback tax on its head
For years the buyback route was tax-friendly to the person selling and expensive for the company. Under the old Section 115QA, the company paid a distribution tax of 20% (over 23% with surcharge and cess) on the gain built into the buyback, and the amount the shareholder received was exempt in their hands under Section 10(34A). The Finance (No. 2) Act, 2024 reversed this completely for buybacks on or after 1 October 2024. Section 115QA no longer applies, so the company pays no buyback tax; instead, the entire buyback consideration is now treated as a deemed dividend in the shareholder's hands under Section 2(22)(f), taxed as "income from other sources" at the shareholder's normal slab rate. For a founder in the top bracket that is a jump from effectively nil to roughly 35% on the whole amount received — not the gain, the whole amount. There is a partial cushion: because the buyback consideration is taxed as dividend, the cost of acquisition of those shares becomes a capital loss (the sale consideration is deemed nil under the proviso to Section 46A), which you can set off against other capital gains and carry forward for up to eight years. The company must also deduct TDS at 10% under Section 194 for resident shareholders (and under Section 195, at treaty rates, for non-residents). The headline is blunt: after October 2024, a buyback is usually the more heavily taxed way for a founder to take money out, because dividend rates are higher than capital-gains rates. That reversal is exactly why the pricing of these deals changed overnight, and why the secondary route deserves a hard look.
Route two: a secondary sale to another buyer
In a secondary, you do not go through the company at all — you sell your existing shares directly to a buyer, most often an incoming investor who wants a larger stake than the primary round alone would give them, or an existing investor increasing their position. This is common in growth rounds: the round is structured as "primary plus secondary", where part of the money is fresh capital into the company and part goes to founders or early employees cashing out a slice. The mechanics are a straightforward share transfer — a share purchase agreement, a transfer deed (Form SH-4), stamp duty, board approval of the transfer, and an update to the register of members. Because no new shares are issued, a secondary does not dilute the other shareholders the way a fresh round does; it simply moves shares from one owner to another. And critically, since October 2024 the secondary is often the tax-cheaper route for the seller, because the proceeds are taxed as capital gains rather than as a deemed dividend — and for a long-held unlisted shareholding, capital-gains rates are lower than slab rates. The catch is that a secondary needs a willing buyer with cash; a buyback only needs the company's own reserves. That is the real trade-off between the two.
The tax when you sell: capital gains on unlisted shares
When you sell shares in a secondary, you pay capital gains tax on the difference between what you sell for and what the shares cost you. For unlisted shares — which is what almost every private startup's shares are — the holding period that matters is 24 months. Hold for more than 24 months and the gain is long-term, taxed since 23 July 2024 at a flat 12.5% without indexation under Section 112 (before that it was 20% with indexation). Sell within 24 months and the gain is short-term, taxed at your normal slab rate. One point founders often get wrong: the ₹1.25 lakh annual exemption you may have heard about belongs to Section 112A and applies only to listed equity shares and equity mutual funds on which STT is paid — it does not shelter gains on unlisted startup shares, which are taxed under plain Section 112 from the first rupee of gain. Set against a buyback taxed at ~35% on the full consideration, a long-held founder's secondary taxed at 12.5% on only the gain is usually the far lighter bill — which, post-2024, is precisely why most founder liquidity now runs through secondaries rather than buybacks. Non-residents and investors claiming treaty relief have their own provisos, so their number can differ.
The price floor you cannot go below (Section 50CA and 56(2)(x))
There is one trap that catches people who try to be clever with the price. You cannot sell unlisted shares at an artificially low figure to shrink the tax, because the Income-tax Act polices both ends of the deal against fair market value. On the seller's side, Section 50CA says that if you transfer unquoted shares for less than their fair market value — computed under Rule 11UA — the FMV is deemed to be your sale consideration for capital gains, so you are taxed as if you sold at the proper price regardless of what you actually charged. On the buyer's side, Section 56(2)(x) says that if someone receives shares for less than FMV, the shortfall (above a ₹50,000 threshold) is taxed as their income from other sources. So an under-priced secondary can be taxed twice over — once on a notional gain the seller never received, and once as income in the buyer's hands. The lesson is that Rule 11UA valuation is not paperwork you can skip; it sets the floor the whole transaction has to respect. This is the same valuation machinery that governs a priced round, and it applies just as firmly to a shareholder selling as to a company issuing.
What this means for ESOP holders
Liquidity is not only a founder's concern — it is the moment an employee's ESOPs finally turn into money, and it comes with its own tax sequence. An employee who has exercised vested options already paid tax once, as a perquisite on the difference between the exercise price and the fair market value on the exercise date. When that employee later sells those shares — into a buyback or a secondary — the second tax event is on the gain from the exercise-date value to the sale price, and the same rules above apply: capital gains if it is a secondary, or a deemed dividend if the company buys them back. A well-run ESOP scheme plans the liquidity route in advance, because whether employees exit via buyback or secondary changes their take-home materially after October 2024. For many startups the cleanest answer is a periodic ESOP buyback or a secondary window tied to a funding round, letting employees sell a portion while the company is still private — the single most powerful retention tool a startup has, provided the tax is modelled honestly before the offer is made.
Where this sits in the startup journey
Founder and employee liquidity is where the cap table you built finally pays out — and it draws on nearly every earlier decision. What your shares are worth in a sale is a function of the cap table and the dilution you took along the way; the price you can transact at is fixed by the same Rule 11UA valuation that governed your rounds; your right to sell, and whether investors get to sell alongside you, sits in the shareholders' agreement (tag-along and drag-along clauses); and for employees it is the endpoint of the ESOP you granted years earlier. It is the mirror image of issuing new shares: one brings money in and dilutes, the other takes money out and does not. For the full running order of building — and eventually cashing out of — a company, the Startup India guide is the map this belongs to. Plan the liquidity route early and you keep more of what you built; leave it to the deal table and the tax decides it for you.
How we handle it at RDA, Baner
At RDA Advisory, Baner, we help founders and teams take money off the table without handing most of it to tax. We model both routes side by side on your actual numbers — a Section 68 buyback against a secondary sale — so you can see, after the October 2024 rules, exactly what each leaves in your pocket: a buyback now taxed as a deemed dividend at slab rates, versus a secondary taxed as long-term capital gains at 12.5%. Where a buyback is the right call we run the full Section 68 process — the board or special resolution, the 25% and 2:1 limits, the filings and the share extinguishment. Where a secondary fits we handle the SH-4 transfer, the Rule 11UA valuation that keeps you clear of Section 50CA and 56(2)(x), the stamp duty and the capital-gains computation. And for ESOP liquidity we structure the buyback or secondary window so employees are rewarded and the tax is planned, not discovered. Office No. 102, Snehraj Apartment, Baner, Pune 411045 · call +91 77570 45059.
Planning a founder or employee cash-out? Model the tax before you sign
Thinking about a buyback, a secondary in your next round, or an ESOP liquidity window? RDA models the buyback-versus-secondary tax on your numbers, runs the Section 68 process or the SH-4 secondary end to end, sets the Rule 11UA valuation that keeps both sides safe from Section 50CA and 56(2)(x), and computes the capital-gains or dividend liability so there are no surprises — so you keep as much of what you built as the law allows. Book a consult at rdatax.in or call +91 77570 45059, or see our company registration & startup advisory service. RDA Advisory, Baner, Pune.
Verification note: A company buy-back of shares is governed by Sections 68 to 70 of the Companies Act, 2013 — funded out of free reserves, the securities premium account or the proceeds of a fresh issue, capped at 25% of paid-up equity capital in a financial year and 25% of paid-up capital plus free reserves in aggregate, subject to a post-buyback debt-to-capital-and-free-reserves ratio of not more than 2:1, on fully paid-up shares, completed within one year of the resolution (board resolution up to 10% of paid-up equity capital and free reserves; special resolution above that up to 25%). For buy-backs on or after 1 October 2024, the Finance (No. 2) Act, 2024 withdrew Section 115QA company-level buy-back tax and instead treats the entire buy-back consideration as a deemed dividend taxable in the shareholder's hands under Section 2(22)(f) as income from other sources, with the cost of the shares allowed as a capital loss (consideration deemed nil under the proviso to Section 46A) and TDS under Section 194 (residents, 10%) or Section 195 (non-residents). A secondary sale of shares is taxed as capital gains: for unlisted shares the long-term holding period is more than 24 months, and long-term gains are taxed at 12.5% without indexation under Section 112 with effect from 23 July 2024 (short-term gains at applicable slab rates); the ₹1.25 lakh exemption under Section 112A applies to listed equity and equity-oriented funds, not to unlisted shares. Transfers of unquoted shares below fair market value (computed under Rule 11UA) attract Section 50CA (deeming FMV as the seller's consideration) and Section 56(2)(x) (taxing the shortfall in the buyer's hands). ESOP shares are taxed as a perquisite on exercise and again as capital gains (or deemed dividend, if bought back) on sale. Rates, thresholds, holding periods, forms and eligibility conditions are set by statute and periodically revised, non-resident and treaty positions differ, and the treatment is fact-specific, so confirm the current position with your CA or tax advisor before acting. This is general information, not legal, tax or professional advice.
