South-east Asia has evolved into a hotspot for startups. Several startups are being incorporated every day in the region, and many are also quickly gaining market share as investments pour in. The region’s startups raised US$25.7 billion in 2021, which was more than twice the amount raised in 2020. This investment rush also topped the previous peak of about US$14 billion in 2018.

That being said, during the last few months, we are starting to see a reversal of the momentum owing to geo-political tensions involving Russia and Ukraine, macroeconomic impact of rising interest rates and commodity prices, as well as Covid-induced lockdowns in certain regions. In the second quarter of 2022, venture funding in Asia declined by 19 per cent as compared to Q1 2022, and was down 20 per cent compared to Q2 2021. This has led to several startups conserving cash and trying to extend their runways, while aiming to grow their monetisation engines while keeping their key team members together.

Skin in the game

Notwithstanding the recent downturn, the pandemic has pushed startups to quickly adapt and innovate. The uncertainty around future investments strained growth engines as founders pivoted to new ways of working by smartly managing cash flows to stay afloat. This included delaying certain payables, managing salary expenses optimally, and also using employee stock ownership plans (ESOPs) as an alternative compensation tool to manage immediate cash flow stress.

Beyond flexible work arrangements and other incentives, companies are also starting to share a piece of the pie with the right talent in the marketplace.

The role of people has become paramount in new-age tech-based companies. Increasingly, companies are devising innovative ways to attract and retain talent. ESOPs is one such way. It clearly sets the intention of companies in not only attracting, but also incentivising the right talent.

ESOPs help companies realise the principle of “skin in the game” among employees. By allowing equity shareholding in the company, employers are also building a sense of ownership and drive among employees to deliver the company’s vision.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

An ESOP develops a sense of oneness, accountability and responsibility, ensuring desirable and sustainable growth in the company. ESOPs also help build a strong brand image of the company. By issuing ESOPs, founders of startups are putting forth a message that they are in the hunt for partners, not just workers who can fulfil their quest to become number one in the marketplace.

Additionally, nuances around ESOPs are changing among founders of startups. They are now accepting the fact that an employee can leave and exit with their share of stocks to pursue their own dreams.

When ESOPs go underwater

But in prevalent market conditions, one pertinent question arises: “What happens to equity compensation during economic downturns i.e. a poor year of financial performance, or when share prices fall for listed companies, or when there is pressure on startup valuations?”

During such periods, companies may consider ways to manage their cash outflows, and employee compensation may be one of the key areas they look into. Employers may opt to convert cash bonuses into deferred equity awards or give employees the option of choosing to “sacrifice” a portion of the cash compensation into equity to manage costs. In such cases, employees may be allocated equity awards or instruments with relatively short vesting periods – enough for the company to turn things around. An employee’s take home pay may be reduced in the short term, but he or she will get the benefit of the share price upside following the vesting of additional equity awards in the future.

Looking at current market conditions, it is also possible that where the valuations of companies have come down or reduced, some of the previously issued options may be “underwater” or unattractive. This tends to reduce employee confidence in equity compensation in what is already an uncertain period. The following aspects need to be carefully considered by companies before taking corrective action including size of the corrective action, timing of the corrective action, impact of setting a precedent, impact on other stakeholders i.e. dilution. Once all such aspects are considered by the appropriate governance body (usually the board), various alternatives are available for the company to choose from:

1. Maintain status quo - if the value of the decrease is not material

2. Reprice the option grants i.e. reduction in exercise price

3. Compensatory issue of fresh grants within the current scheme

4. Option exchange i.e. swap current options with new grants with new terms

In summary, this corrective action becomes a multi-stakeholder decision and a win-win needs to be constructed. As with most complex decisions, there is no ‘one-size fits all’ approach.

Technology enabling ESOPs

Technology is enabling companies to manage ESOPs effectively. Tech platforms are providing employees with transparency in knowing the status and details of their ESOPs. Additionally, events such as exercising one’s options or participating in a liquidity event are all done through the technology platform, thus bringing trust and transparency to the whole process.

The push of tech is certainly driving the attractiveness of ESOPs not only among employees, but also among employers. Awareness and the intent to use tech platforms to manage ESOPs is increasing among startup founders.

Going forward – with the influx of more and more innovative startups in the region – the viability of ESOPs will also increase. ESOPs provide an opportunity to non-founders to attain financial independence in a very short period of time. When used judiciously, it can prove effective for both the employee and the employer. For employees, don’t be surprised if you start seeing your current and future employers getting more and more creative with their equity compensation packages giving you a greater freedom of choice. The world of ESOPs is constantly evolving.

The writer is CEO and co-founder of Qapita