Start-ups hit upon novel idea that gives employees top money and boosts promoters too

Employee stock options (ESOPs) is a great tool for start-ups to lure talented employees without straining their finances. However, it comes with a downside. Unlike in established companies, start-ups offer ESOPs to larger number of employees, which eat into the promoters' sharepool, diluting their interests.

Promoter buyback

To balance both these needs, promoters seem to have hit on a novel idea. Recently, automobile e-marketplace Droom raised $30 million, or around Rs 200 crore. Of this, the company will spend Rs 50 crore in buying back shares of 60 employees, who have been working with the company for over three years.

Market experts believe that promoters buying back shares from employees as a trend will pick up since ESOPs along with multiple funding rounds are eating into the stake and ownership rights of the founders. ESOPs are given to compensate for the inability of start-ups to pay market rates. For example, a certain percentage of their salary is compensated through ESOPs.

Cash out opportunity

Buybacks land employees into an early payday without having to wait for a distant dream of an IPO. "It is a great opportunity for employees to cash out, especially in a start-up where there is no formal market for liquidation. While ESOPs are given out with a certain projection and parameters, the market might not respond in the same manner, going ahead. In the case of many listed company ESOPs, the conversion price has not been remunerative in a fallen market," Uday Patil, director of investment banking at Keynote Corporate Services, says.

However, Gaurav Dua, head of research at Sharekhan, says that cashing out depends on the individual financial needs of employees. "Some employees may want to cash, but those who see value in holding on to the shares might want to hold on to it," he says.

Future value

There are many ways in ESOPs can be rewarding. The employees who received ESOPs of Infosys have made millions allowing them to retire rich. Being a part of fast growing companies, whose size, value and valuation can multiply within a few years, allows them to gain wealth which steady salaries cannot offer. In fact, it is the possibility of this gain that attracts many employees from large companies to join start-ups, in addition to the satisfaction of building a company from the ground.

Loyalty to an organisation is also one reason why employees hold on to their shares. While ESOPs never offer them a Board seat, most employees who are not in immediate need of cash and intend to continue working for an organisation might not be active sellers. Inversely, employees who do not see long-term career prospects would prefer to exit quickly.

Market experts, however, say that there are risks along with rewards that ESOPs can offer in the long run. "A large number of SMEs who are listed have been oversubscribed. But a large chunk of the listed SMEs have been trading below their IPO offer price. In general, promoters are never known to pay top dollar to employees but are more keen on holding on to their ownership and this will be a trend that will catch up," says a Mumbai-based private equity investor.

PROS AND CONS

While ESOPs are given out with a certain projection and parameters, the market might not respond in the same manner, going ahead

Being a part of fast growing companies allows employees to gain wealth which steady salaries cannot offer

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Buybacks land employees into an early payday without having to wait for a distant dream of an IPO

By: Katya B Naidu

Source: DNA Money