ESOPs give employees the option to purchase shares at a pre-set strike/exercise price after a vesting period (often 4 years with a 1-year cliff). If the company's value rises, the gain is the difference between market value and strike price. They're a core retention and wealth-creation tool, especially in startups where cash comp is tighter.
In India
Taxed twice in India: as a perquisite at exercise (on the spread) and as capital gains at sale. Eligible startups get deferral of the perquisite tax. Understanding this is essential before employees exercise.
In practice
An employee is granted 4,000 options at ₹100 strike, vesting over 4 years. After the company's value grows, they exercise when shares are worth ₹500 - a paper gain of ₹400 × 4,000 = ₹16 lakh (taxed as perquisite at exercise).