selling ESOP stocks
Employee Stock Ownership Plans (ESOPs) have emerged as a famous device for Indian startups and companies to incentivize employees and align their interests with the company’s growth. However, expertise in the journey from possession to liquidity is critical for employees holding ESOP shares. This article delves into the process of selling ESOP stocks and highlights the recent example of Flipkart to demonstrate liquidity activities.
ESOPs provide ownership and a financial incentive to the business enterprise’s achievement. However, while receiving ESOPs can be thrilling, understanding a way to release liquidity from these stocks is crucial for maximizing their value.
What Are ESOPs?
ESOPs are a worker advantage plan that offers personnel the right to shop for shares inside the enterprise at a predetermined price, frequently lower than the market. ESOPs are typically granted as part of a reimbursement bundle deal, presenting personnel with an ownership stake inside their enterprise.
In startups, ESOPs are mainly common, as they help align personnel’s interests with the business enterprise’s prolonged-time period desires. Employees are more invested in the commercial enterprise organization’s fulfillment, which can pressure average performance and engagement. However, the economic value of ESOPs is simplest realized when personnel are capable of selling their shares through a liquidity event.
The Journey from Ownership to Liquidity
While owning ESOP stocks is a sizeable financial incentive, personnel must undergo several ranges before they can convert this possession into actual liquidity:
1. Granting of ESOPs: Employees are granted ESOPs as a part of their compensation package deal. These options generally vest over a period of time, which means employees earn the right to workout their options and buy shares incrementally.
2. Vesting Period: The vesting period is the time over which employees earn their ESOPs. During this time, employees gradually earn the right to exercise a portion of their ESOPs. For example, an organization provides ESOPs that vest over four years, with 25% vesting each year.
3. Exercise of Options: When the options have vested, employees can work out them, which means they can buy shares at the predetermined exercise price set as per the organization’s ESOPs setup rule. This price is typically lower than the market fee, offering a right away economic gain.
4. Holding Period: After exercising their options, employees preserve the shares. During this era, the price of the stocks can fluctuate based on the enterprise’s performance and marketplace conditions.
5. Liquidity Event: A liquidity occasion is an opportunity for personnel to sell their stocks and comprehend their cost. This can occur via diverse manners, inclusive of an initial public offering (IPO), acquisition, or buyback
— Initial Public Offering (IPO): When a company is going towards a mainboard IPO, personnel can sell their shares on the open marketplace.
— Acquisition: If the company is obtained, the acquiring company might work out the employees’ shares as part of the deal.
— Buyback: Companies may additionally provide to shop for again stocks from employees, offering immediate liquidity.
How Does Selling to an ESOP Unlock Liquidity?
One of the principal reasons commercial enterprise proprietors recall promoting to an ESOP is the opportunity to free up liquidity. As proprietors are trying to find an exit, they could sell all or part of their shares to the ESOP, receiving cash or based payouts in return. This lets in for a gradual transition of possession whilst securing liquidity for the vendor.
Let’s recognize these liquidity activities with the latest examples in the startup landscape:
Many Indian startups like Flipkart, Zomato, and Swiggy have embraced ESOPs, supplying extensive possession to employees. But the real mission for employees lies in changing these stocks into cash.
1. Buyback Opportunities:
Startups in India generally offer buyback opportunities wherein they repurchase shares from employees. This is a manner for personnel to cash out, although the enterprise isn’t publicly indexed. Buybacks typically take place when a startup has raised huge capital or is near reaching profitability.
A recent example of ESOP liquidity befell Flipkart. In July 2023, Flipkart facilitated an enormous Employee Stock Ownership Plan (ESOP) buyback, marking certainly one of the most important such occasions inside the Indian startup ecosystem. Flipkart did a $700 million ESOP buyback, benefiting over 24,000 current and former personnel of Flipkart and Myntra. This buyback is a one-time cash payout to employees who held stock alternatives on Flipkart
This buyback allowed employees to liquidate their stock alternatives, supplying huge financial profits. For example, PhonePe founders Sameer Nigam and Rahul Chari were predicted to get hold of cash payouts of $20–25 million via liquidating their stock options on Flipkart.
2. Initial Public Offerings (IPOs):
For many startups, the closing purpose is an IPO. When an organization is going public, personnel can sell their stocks at the open market. However, IPOs can take years, and employees may need to wait for long periods to realize the price of their ESOPs.
In 2021, personnel of Zomato benefited from an especially successful IPO, letting them convert their ESOPs into cash at marketplace cost. This changed into a turning factor for employees who had held stocks for years, highlighting the potential rewards of ESOPs once a company is listed.
3. Acquisitions and Mergers:
When a startup is obtained or merges with some other business enterprise, it often triggers an event wherein personnel can sell their stocks. In such eventualities, obtaining corporations generally offer to buy returned stocks as part of the deal.
Flipkart’s Acquisition through Walmart: Flipkart employees reaped large rewards when Walmart acquired the company. Walmart bought ESOPs from employees, offering extensive returns for folks who had stocks inside the corporation. This acquisition became a model for Indian startups, showcasing the blessings of preserving ESOPs for the duration of main transactions.
Key Factors: What You Should Consider When Selling ESOPs
While the concept of proudly owning stocks and gaining liquidity is attractive, promoting ESOPs isn’t usually truthful. There are certain points:
- Tax Implications
ESOPs are subject to taxation under two main events:
— At the time of exercise: Employees are taxed on the distinction between the exercising rate (the rate at which they purchase the shares) and the fair marketplace price of the shares.
— At the time of sale: If the shares are sold for greater than the honest marketplace fee, the worker is taxed at the capital profits. Short-time period or lengthy-time period capital gains tax is relevant, depending on the holding duration.
- Liquidity Windows
Liquidity windows, where companies offer to buy back shares, are typically limited. Startups may not offer these opportunities every year, so employees need to stay informed and make strategic decisions about when to sell their shares.
- Market Conditions:
The value of ESOPs is associated with the company’s valuation. For employees in Indian startups, market conditions play a significant role in determining when the company offers liquidity or goes public. A downturn in the market might delay these opportunities.
- Vesting Periods:
Employees want to complete the vesting duration before they are able to exercise their ESOPs. Typically, vesting schedules unfold over 4-five years, which means employees ought to remain with the employer for a fixed period before they are able to promote their stocks.
- Seek Professional Advice: Understanding the approach of ESOPs, liquidity events, and tax implications can be complex. Professional financial or legal recommendations can help personnel make more knowledgeable choices approximately while exercising their options and promoting their stocks.
Conclusion
ESOPs are an appealing advantage for personnel, presenting a direction to ownership and financial rewards tied to the organization’s achievement. However, the adventure from receiving ESOPs to understanding liquidity involves multiple tiers and calls for careful making of plans. Employees have to understand the phrases in their ESOPs, navigate the tax implications, and preserve a watch on liquidity occasions like IPOs, acquisitions, or buybacks.
As the Indian startup ecosystem evolves, liquidity occasions like Flipkart’s current buyback turn into extra common, providing personnel greater opportunities to sell their stocks and unencumbered the cost of their ESOPs. By staying informed and looking for the proper recommendation, personnel could make the most of their ownership stakes and attain their financial desires.
