ESOPS feel funding chill as start-ups skate on thin ice
Employee earnings from ESOPS have come down from $400 million in 2021 to less than $100 million this year
As the purported start-up funding winter lingers on, employee stock ownership plan (ESOP) payouts among fledgling companies have hit the skids. Employee earnings from ESOPS have come down from the highs of $400 million in 2021 to less than $100 million this year, according to equity management platform Qapita.
While the funding torpor has had no significant impact on the issuance of ESOPS, a liquidity crunch has caused the wellspring of ESOP buyback programmes to run dry.
Start-up funding in India hit new heights in 2021, when investments reached a total of $44.5 billion. Since then, capital has become much harder to come by. Total funding fell to nearly half in 2022 at $26.6 billion, while start-ups raised just $2.8 billion in the first quarter of the current calendar year, according to data from Tracxn, a market intelligence platform.
ESOP buybacks, the primary method of liquidation for employee-owned stocks, have followed the funding trend as companies look to reduce cash burn and improve margins. Years 2021 and 2022 combined saw a record quantum of ESOP buybacks of more than $700 million, on the back of increased venture capital and private equity investments.
In 2022 alone, over 40 companies announced ESOP buyback programmes. In contrast, only nine companies have announced programmes until May 2023 so far, signposts data from Qapita. These include a massive $700-million payout by Flipkart, among other notable companies like educational technology startup Sunstone, logistics firm Porter, artificial intelligence and analytics firm Tredence, and direct-to-consumer brand The Souled Store.
Additionally, fewer companies are disclosing the quantum of their liquidity programmes while offering ESOP topups or accelerated vesting instead of cash increments.
“With funding freeze showing little sign of a thaw, the Indian start-up ecosystem has been facing ESOP liquidity challenges,” says Manish Khanna, cofounder, Unlisted Assets, a technologydriven platform for buying and selling unlisted shares.
“Most of the start-ups are increasingly focusing on conserving cash and maintaining liquidity. Consequently, we have not seen many announcements on the ESOP buyback front,” he adds.
ESOP holders in Indian start-ups, which are mostly unlisted companies, typically liquidate their shares through company-led programmes and not through an open secondary market. In the absence of frequent ESOP buyback programmes, the liquidity options for employees are limited.
“Companies are also exploring alternative liquidity mechanisms, such as third-party sale programmes by finding investors willing to do a secondary purchase of shares. However, in the funding winter, the number of investors willing to purchase secondary shares is also lower,” says Ravi Ravulaparthi, chief executive officer and co-founder, Qapita.
Moreover, most of the ESOP inventory gets traded in the market at a discount to a fair valuation. With less exit options, the discount becomes steeper if there are fewer buyers in the market.
“The price at which ESOP holders liquidate their options is typically benchmarked at the last funding round. Most liquidity programmes in 2021 and 2022 were offered on a par with their previous funding rounds,” adds Ravulaparthi.
Employees who have converted their ESOPS into shares, he says, can sell them in the secondary market. “In such cases, the shares are trading at discounts to previous rounds.”
While start-ups have rationalised their growth strategies to cut down costs, the trend of issuing ESOPS, observe industry watchers, has kept its pace.
“During a funding lethargy, ESOPS work as a good tool for companies as there is zero cash flow impact for them, which helps conserve valuable cash,” says Shravan Shroff, co-founder, ESOP Dhan.
ESOPS are a cash flow-friendly instrument. In a difficult funding environment, the issuance of ESOPS should witness an increase.