Startups and ESOPs Buyback

Startups in India are on their way to conquer the world. The 1.3 billion ‘youth-centric population’ serves as a huge market to execute revolutionary ideas. We see innovation and new ideas popping up at every corner in the country.

The startup ecosystem has seen a boom in recent years. By the end of 2019, India had a total of 80,000 startups, which together raised USD 10bn. This puts India’s venture capital activity just behind America and China. In spite of billions of dollars pouring into the entrepreneurial ecosystem every year, there are startups that have ‘bootstrapped’ their journey. They start out with a little capital, a handful of talented people and build something truly amazing.

ESOPs are a type of employee benefit plan which intends to encourage employees to acquire stocks or ownership in the company. The ESOPs buyback trend started back in 2018 when Flipkart announced a 100% buyback options of vested ESOPs. Since then, companies such as Oyo, Unacademy, Meesho, CarDekho, Razorpay, Swiggy, Byju’s, and Zerodha have rewarded their employees via stock buyback or secondary transactions. It is a great way to retain talent and incentivize financially.

What is ESOPs Buyback?

• A company allots ESOPs to its employees with certain terms and conditions attached to it. (Employees based certain prerequisites such as vesting periods, performance, etc.)

• For companies listed on the stock market, employees can sell their ESOPs at the prevailing market price once their lock-in period is over. For unlisted companies, employees can sell vested ESOPs back to the employer (buyback).

• Any amount that the employees receive through these ESOPs sales becomes part of their income. It is also subjected to taxes as per prevailing income tax rates.

When it comes to a buyback of shares of an unlisted company, the provisions under sections 10(34A) and 115QA of the Income Tax Act shall intervene. As per section 10(34A), any income arising to a shareholder (including ESOP-shares) on account of buyback of unlisted shares by the company shall be exempt in the hands of such shareholders. Further, as per section 115QA, the tax @ 20% shall be paid by the unlisted company on the buyback of its shares.

Tip

When it comes to a buyback of shares of an unlisted company, the provisions under sections 10(34A) and 115QA of the Income Tax Act shall intervene. As per section 10(34A), any income arising to a shareholder (including ESOP-shares) on account of buyback of unlisted shares by the company shall be exempt in the hands of such shareholders. Further, as per section 115QA, the tax @ 20% shall be paid by the unlisted company on the buyback of its shares.

Stock Broker Champions – Zerodha

Zerodha had allocated an ESOPs pool worth INR 200 cr. to 850 employees in September 2019. A few days ago it announced a buyback worth INR 65cr. from 700 employees. A buyback at INR 700 per share – which is more than 4 times the book value (INR 170 cr.).

The customer base of Zerodha has increased significantly in the past few months. The stock market is most active now since 2007. First-time investors have turned towards trading due to market volatility in the COVID-19 lockdown.

The stock-broking entity has bootstrapped its journey with zero external funding. Hence, it has never been ascribed a valuation. But after this buyback worth INR 65 cr., the company has claimed a unicorn valuation worth INR 7,000 crore (roughly USD 1 bn)!

Zerodha has built a massively successful business in the last 10 years. It has also funded other budding startups like – Smallcase, Finception, Digio, Streak, Quicko, and many more. With ESOPs it has managed to keep employees’ stake and retain senior talent. And there is definitely a delicate sense of pride when you are a part of business success.