July was a defining month for employees in the Indian startup ecosystem. Close to 19,000 ESOP holders of Flipkart collectively took home a whopping $700 million in cash as part of a one-time ESOP liquidity payout. Chatter about how this will increase the real estate prices around the outer-ring-road in Bengaluru aside, this was indeed a pivotal moment for the startup ecosystem as tens of thousands of employee owners realised value for their contribution to building an institution over the last decade. This has been the largest ESOP liquidity event in India’s startup ecosystem, taking the total quantum of ESOP liquidity programs in startups to ~$1.5 billion over the last three to four years based on the data collated by Qapita.
The rise and rise of ESOPs
Employee ownership through equity compensation programs has been on the rise in Indian companies over the last few years. Founders and HR leaders today realize that it is important to forge a long-term partnership with their key employees for sustainable and long-term value creation. This necessitates founders and HR leaders to look at their key talent as stakeholders in their business and make them feel like true owners of the company. Equity compensation instruments help crystallize this relationship and align incentives for the long term, ensuring skin-in-the-game for employees.
As per ESOP Direct’s latest Equity Compensation Survey which covered over 300+ listed and unlisted companies, we see that companies are increasingly broad basing their ESOP programs to cover a larger pool of employees. In terms of ESOP scheme design, we also see a trend towards employee-friendly policies in terms of more frequent vesting schedules, longer exercise periods and periodic top-up grants, among others. For e.g., between 2020 and 2022, the number of unlisted companies covering more than 10% of their employees through ESOP schemes has increased from 42% to 58%, implying that 16% of companies have broad-based their programs to cover a larger number of employees. Similarly, we see that in 2020, only 31% of unlisted companies had an ESOP pool size greater than 5%. However, by 2022, the number of unlisted companies with an ESOP pool size greater than 5% had drastically increased to 76% in 2022, implying a willingness by companies to offer a larger share to ESOPs. Refer to the chart below:
ESOP Liquidity: The Proof of the Pudding
While employee-friendly ESOPs, broader coverage and larger pool sizes signal the intent of companies to build a long-term relationship with their employees, the proof of the pudding, as they say, is in the eating. In this context, we have seen that several dozen companies over the last two years have offered liquidity programs to their employees with vested stock options. This has meant many employees have benefitted from these liquidity programs which have helped boost their morale.
From the data compiled by Qapita, the years 2021 and 2022 saw a record $700 million of capital deployed for ESOP liquidity programs by 70+ unlisted companies. The table below captures some of the large ESOP liquidity programs announced in the last 2 years:
The Funding Winter and the scope for Secondaries
After a deluge of funds allocated for ESOP liquidity programs over the last two years, 2023 has seen a decline in the quantum allocated for ESOP liquidity programs across startups and unlisted companies. The funding winter has made companies across the spectrum focus on sustainable growth and cash conservation to increase their runways. This has impacted the quantum being allocated to ESOP liquidity programs. Apart from the one-time Flipkart ESOP payout in 2023, only nine other companies have announced ESOP liquidity programs worth $40 million in the first half of 2023 (compared to over $250 million in the same period last year).
However, we see this tide changing in the future as funding flows improve and investors seek to deploy the record amounts of dry powder raised over the last couple of years into the startup ecosystem. Moreover, as companies across the spectrum have restructured teams to cut costs, it is even more important for such companies to offer liquidity to their key employees to motivate and retain them.
MD & Head
Qapita Marketplace
On the demand or capital provider side, we see several factors that will continue to drive interest in the Indian startup ecosystem. potential These include India’s continued attraction as a global investment destination, emergence of larger domestic pools of capital and increased appetite to invest in alternative asset classes esp. startups and unlisted companies. With both the demand side (capital) and supply side (ESOPs) slated to multiply over the next few years, we see the role of secondary transactions in the unlisted space becoming important going forward to enable stakeholders to find the much-needed liquidity in private markets.
To sum-up, while 19,000 “Flipsters” taste the fruits of their labour having built Flipkart over the years, we hope this event is also a harbinger of many more similar fables of ESOP.
