Large scale tech companies in India are looking at ways of rewarding their employees — one being through Employee Stock Ownership Plan (ESOP) buyback plans. In the first half of 2021 itself, around a dozen companies announced their ESOP buyback plans worth more than $100 million.
Fintrackr’s research shows that companies such as Udaan, ShareChat, Razorpay, CRED and several others had already bought stocks to the tune of $73 million held by employees. Meanwhile, Zerodha has emerged as the largest buyer of ESOPs in 2021 (so far) with $27 million. The transaction is reportedly in process.
B2B e-commerce unicorn Udaan’s active employees offloaded ESOPs worth $23 million to the company’s investor in a secondary stock buyout programme in April. ShareChat, which attained the ‘unicorn’ status in April, bought back over $19 million worth ESOPs from existing and erstwhile staff.
ESOP buybacks and secondary stock buyout by investors have picked up in the past two years, which investors say is a sign of the ecosystem having come of age.
“These transactions show that the Indian startup ecosystem has matured and is at par with evolved ecosystems like Silicon Valley in terms of adopting best practices,” said a venture capital investor, requesting anonymity.
Last year, too, several companies bought back stocks from their employees. According to Fintrackr’s data, 12 companies including Zerodha, Swiggy, Unacademy, FirstCry, Urban Company and Meesho bought close to $50 million worth of ESOPs from their employees in 2020. Swiggy and Zerodha turned out to be the biggest fortune creators for their employees in the last year with $9 million worth of buyback each.
How the culture of ESOP evolved over the years
Prior to the massive ESOP buyback by Flipkart in 2018, holding stocks wasn’t a norm or popular practice for both startups and their employees. But as hundreds of former and existing Flipkart employees received significant payouts after Flipkart set aside $500 million to buy their shares, the attitude towards ESOPs started to change as a potentially valuable instrument.
At that time, Flipkart bought ESOPs from hundreds of employees and many of them became millionaires. In the same year, around 300 Paytm’s employees also sold their stocks worth Rs 300 crore to Canada-based Discovery Capital in a secondary deal.
Following these fortune-making events, faith in ESOPs has increased multifold and gotten stronger in the past two years with many companies buying back ESOPs or facilitating liquidity to former and existing employees via secondary deals.
Employees play a pivotal role in the success of any startup. Besides co-founders and backers, employees invest themselves towards shaping and achieving the organisation’s goal. Hence, they deserve to be awarded through such buyback and secondary deals.
“We did three ESOPs buyback events in the past four years and they proved to be a confidence booster for employees. These cashouts help to meet individual goals and give them a sense of ownership, which eventually translate into greater ownership and responsibility,” said Abhiraj Bhal, co-founder and CEO of Urban Company.
So far, Urban Company’s employees have sold $8 million worth of stocks through the company’s ESOP buyback and secondary programs in 2017, 2018 and 2020.
In high growth companies, buying ESOPs appears to be the only way to increase or allocate stake to new investors. According to the VC quoted above, founders of unicorn or decacorn don’t want to dilute their stake. “Finding a spot in such companies is tough for the investors and buying partial stake of employees has turned out to be a popular practice,” the VC added.
Startups added $700 Mn worth stocks in their ESOP pool since Jan 2020
Apart from offering exits to ESOPs holders, close to 20 companies had expanded their ESOPs pool in 2020. According to Fintrackr’s estimate, collectively they had expanded their ESOP pool by over $530 million in 2020. Byju’s and Oyo topped the list with $208 million and $143 million addition respectively. Swiggy, ShareChat, Unacademy and Rebel Foods were other prominent startups to expand their ESOPs pool in 2020.
According to experts in hiring and people management, the ESOP component is a must when startups go for hiring across functions right from CXO to mid-level. “Typically, the ESOP component is anywhere between 60% to 100% of the annual compensation (read CTC) for junior-level employees while it goes up to 3X for the mid-leadership positions,” said one of the senior executives of a consulting firm. The person requested anonymity as he’s not authorised to speak to the media.
“In case of CXO level positions, the ESOPs component jumps up to 3-4X of the CTC or even more if the candidate is highly skilled and has a proven track record,” the person added.
Expansion of the ESOPs pool by several growth-stage companies continues in 2021 as well. As of June this year, nine companies have expanded their pool to the tune of $170 million. The number is likely to double in the second half of the ongoing year, asserts a venture capitalist who didn’t wish to be named.
Challenges continue to prevail
The quick pace at which ESOP allocation, expansion and buyback has been catching on in India is a good sign, the way it is taxed continues to be a challenge for employees. Post vesting, if an employee wants to exercise their ESOPs, they have to pay capital gains tax. Capital gain is basically a tax over the price difference between fair market value and exercise price.
“This needs to be addressed as the current taxation is very harsh. Why would someone pay capital gain to exercise ESOP on which he or she didn’t make money,” said Deepak Abbot, co-founder of indiagold. “Government should tax ESOPs only when the person encashes from it. If it happens, the faith in ESOPs would grow multiple times.”
Currently, many ESOPs holders across companies don’t exercise their ESOPs because they don’t want to pay capital gain tax. Two years ago, the government acknowledged the problem and eased the burden of taxation on employees by deferring the tax payment by five years or till they leave the company or sell their shares (whichever is earliest). But the catch here was that it was only applicable to companies recognised under the Startup India programme.
This, too, comes with a caveat. Startups under this programme that seek tax deferment for ESOPs need to take special permission from the Income Tax department. According to experts dealing with ESOP related tax, less than 1% of startups (below 500) under the Startup India Programme have been qualified for such relief.