Over the previous 5 years, India’s startup ecosystem has shifted from a part of ample capital and speedy scaling to at least one characterised by funding moderation and valuation resets, leading to longer paths to liquidity.
Between 2020 and 2022, Indian startups raised over $120 billion in enterprise funding, driving aggressive hiring and growth. From 2023 onwards, funding volumes declined sharply, and IPO timelines had been pushed out. Profitability changed progress at any value as the first working focus.
It’s inside this modified atmosphere that the Union Funds 2026 has assumed significance, not as a reset, however as a sign of how India intends to structurally assist its startup and MSME ecosystem by means of the subsequent part of progress.
Funds 2026 laid out a robust assist framework for MSMEs, together with a Rs 10,000 crore SME Development Fund, a Rs 2,000 crore top-up to the Self-Reliant India (SRI) Fund, and expanded TReDS-linked measures to enhance credit score entry and liquidity for small companies.
These interventions are significantly related for startups and deeptech ventures, lots of which function as MSMEs throughout their formative and scaling years. Whereas entry to capital and liquidity stays important, the Funds additionally brings into sharper focus a structural friction that was beforehand masked by straightforward capital: the problem of retaining expert expertise in long-gestation innovation companies.
Expertise retention, ESOP taxation, and portfolio danger
As funding tightened and money compensation flexibility declined, ESOPs turned important for aligning worker incentives with long-term enterprise outcomes. That is significantly true for deeptech and AI startups, the place product growth cycles can lengthen seven to 10 years and require sustained dedication from extremely specialised engineers and researchers.
India at this time has over 3,500 deeptech startups, but continues to face a scarcity of skilled expertise in areas equivalent to chip design, superior AI modelling, and utilized analysis. These professionals are globally cellular and actively recruited by firms within the US, the UK, Singapore, and Israel markets, the place fairness incentives translate extra predictably into long-term wealth creation.
From a enterprise capital perspective, expertise attrition will not be merely an operational concern. It’s a portfolio-level danger that instantly impacts execution timelines, institutional data, and valuation outcomes.
India’s present tax framework compounds this problem. ESOP taxation happens in two phases. At train, the distinction between the truthful market worth of the shares and the train worth is handled as perquisite earnings and taxed as wage, despite the fact that no liquidity is realised. At sale, the distinction between the sale worth and the truthful market worth at train is taxed as capital beneficial properties, sometimes 10-15% for listed shares and 20% or greater for unlisted shares.
Whereas a restricted tax deferral exists for eligible startups, the underlying cash-flow mismatch stays unresolved. For long-gestation deeptech firms and MSME-led startups with delayed exits, this considerably weakens the effectiveness of ESOPs as a retention device.
Funds 2026, MSMEs, and the boundaries of capital-only assist
The emphasis on MSMEs in Funds 2026 by means of the SRI Fund, SME Development Fund, TReDS growth, and initiatives equivalent to She-Marts for ladies entrepreneurs acknowledges that small companies and startups are central to employment era and innovation.
Nonetheless, whereas these measures deal with capital availability and liquidity constraints, they don’t absolutely resolve the motivation misalignment confronted by workers who’re anticipated to decide to long-term worth creation with out near-term liquidity.
As MSMEs scale into venture-backed enterprises and innovation-led startups, fairness possession turns into a vital mechanism for shared worth creation. With out corresponding reform in how ESOPs are taxed and structured, the advantages of improved capital entry danger are being diluted by ongoing expertise attrition and execution fragility.
International comparisons and the case for reform past funds 2026
A comparability with world startup ecosystems underscores why ESOP coverage has develop into a strategic lever within the competitors for superior know-how expertise. Within the US, worker inventory choices are usually taxed nearer to the purpose of sale, aligning tax legal responsibility with precise wealth realisation.
The UK’s Enterprise Administration Incentive scheme applies capital beneficial properties tax upon exit fairly than at train. Singapore permits tax deferral on qualifying worker share plans, whereas Israel has constructed an fairness framework designed to assist long-horizon innovation.
Whereas India ranks among the many world’s largest startup ecosystems by quantity, it continues to path the US and China in deeptech capital depth and superior analysis output. This hole is magnified when compensation constructions fail to transform long-term worth creation into tangible worker outcomes. Towards this backdrop, enterprise capital corporations more and more view ESOP reform not as a tax concession, however as a structural necessity.
The chance now lies past Funds 2026. Linking ESOP taxation extra carefully to precise liquidity occasions, increasing the scope of deferral provisions, and simplifying compliance necessities would assist deal with execution dangers confronted by venture-backed startups and MSMEs alike. As India seeks management in synthetic intelligence, local weather know-how, and superior manufacturing, such reform is foundational to sustaining long-term innovation and worth creation.
Ranjeet Shetye is a Deeptech Investor, Mentor at YourNest VC, COO, and CPTO at MapMyCrop
(Disclaimer: The views and opinions expressed on this article are these of the writer and don’t essentially replicate the views of YourStory.)
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