No performance riders on ESOP grants to founders of India's new-age firms

Experts question why such endowments in India's new-age companies are not comprehensively linked with performance targets

On any day, one can find founders of Indian tech companies holding up their Silicon Valley peers like Elon Musk as role models, talking about things like innovation and regulation where the US tech hub fares much better.

Of course, comparisons always sound sweeter when others are playing ball, not when the ball lands in their court. One such instance is corporate governance related to stock grants.

“In the West, the best practices for stock grants are for incentivising top executives to achieve specific performance goals in the future. Some founders of tech companies in India are getting stock grants as rewards for past performance and without the conditionality of attaining targets going forward,” said Mohandas Pai, former CFO of IT behemoth Infosys.

Earlier this month, fintech major Paytm’s founder and CEO Vijay Shekhar Sharma said in a letter to shareholders that his stock options in the company will vest only when its share price crosses the initial public offering (IPO) level on a sustained basis.

After a blockbuster IPO where Paytm’s scrip was priced at Rs 2,150, the company has been on a downhill trajectory starting from its battered debut on the bourses. As of Thursday noon, it was trading at Rs 641 — 70 per cent below its IPO price.

“That letter to shareholders means nothing in my view. First, it does not define what sustainable means: Does it mean the average price of one month, six months or one year? And more importantly, it is only the pre-IPO investors such as venture capital and private equity firms who will benefit if the price just crosses the IPO level when their lock-in expires and they can cash out comfortably,” said an analyst of a brokerage firm who requested anonymity.

“The mutual funds and retail investors stand to only lose and come out of this charade of battered tech stocks with a red face,” he added.

Another grouse that industry insiders have about the company’s employee stock option plan (ESOP) is the lopsided exercise price with Sharma, who owns 9.1 per cent in the company, accounting for a lion’s share of the grants.

“Paytm had issued around 28 million ESOPs just before its IPO. These ESOP grants are deep in-the-money (exercise price of Rs 9 versus IPO price of Rs 2,150). Hence, ESOP costs are elevated for Paytm, and this will be a recurring annual expense of around Rs 1,600 crore going forward,” said analysts of brokerage firm Macquarie in a report earlier this year.

“Interestingly, around 76 per cent of the ESOPs granted before IPO were to the founder-CEO, Vijay Shekhar Sharma,” the report added.

But it is not just Paytm shareholders who have to bear the weight of stock grants to founders.

Zomato granted 368 million ESOPs to founder and CEO Deepinder Goyal in April of 2021, just before its IPO plans were announced. The grant was approved by its private shareholders before the IPO in July, but again had to be ratified after the listing to align with regulations in September last year.

That’s when as many as 61 per cent of the food aggregator's institutional investors, who hold 15.5 per cent in the company, voted against the ESOP plan, according to data collated by Institutional Investors Advisory Services. But the proposal went through nevertheless as 100 per cent of public non-institutional shareholders, which include VC and PE firms, voted in favour, with 90 per cent of the total votes supporting it.

“Granting stocks to founders just before the IPO at very low prices is a perverse thing to do as they are rewarding past performance, if any, and making future shareholders pay the cost in the form of a compensation charge. These kinds of things happen because the board members of these companies are not doing their jobs properly,” said Pai.

However, one important thing to note is that granting founders huge stock compensation before IPOs is something Silicon Valley companies do as well — and the issue has attracted controversy on Wall Street in the recent past for start-ups such Bird, Archer Aviation, Palantir and DoorDash.

In India, experts are of the view that such problems are cropping up because of a confusion over what the over-hyped tag of “Founder” really means.

“Quite a few of these new-age companies do not have any identified promoters. Traditionally, a founder or entrepreneur upon public listing would be a promoter and regulations do not allow promoters to get any stock grants,” said Suraj Malik, senior advisor at Burgeon Law who works with family offices.

“Today, tech start-ups are also elevating senior management personnel who might have come in later as co-founders. In a way, this tag does not create any obligations that apply to promoters and also permits them to be a part of the stock compensation structure,” he added.

A veteran venture capital investor with multiple unicorns under his belt said these are still early days of tech start-ups going public and such issues will get ironed out eventually.

“In our world, start-up founders may get rewarded with ESOPs for things like being able to bump up the valuation in a subsequent round of funding or successfully navigating an acquisition of a significant competitor. With time, the companies that list in the share market will understand what behaviour is rewarded there,” he explained.

“Also, the new-age companies have mostly sold 10-15 per cent of their entire shareholding in the IPOs. That’s why incoming investors have not been able to get their way in terms of corporate governance. It remains to be seen what happens when the PE-VC investors cash out over the next one year,” he added.