Employee Stock Option Plans(ESOPs) have long been an effective tool by startups to limit attrition and improve engagement by employees as the growth of their salary is linked to the growth of a company.

They have proved lucrative for employees of several startups in India. For instance, in December 2017, Flipkart bought back ESOPs worth $100 million, making it the largest share buyback program by an unlisted company in the country.

Similarly, Paytm, Ola Cabs, Rivigo have provided opportunities to existing and former employees to liquidate ESOP units through secondary share sales.

But the problem with ESOPs is that generous exits for employees of the kind mentioned above are rare. Typically, there is a long wait for current and former employees. That apart, there is the vesting period —a condition to remain with the company, usually four years, for an employee to be issued these shares.

Employees then have to wait for the respective companies to get public. The best bet for employees then is a company announcing an ESOP repurchase or when a new investor wants to buy additional shares from the ESOP pool. All these are big ‘ifs’.

But there seems to be an end to years of sobering news for employees. A new crop of dealers trading and facilitating trading in shares of unlisted companies and ‘pre-IPO companies’ — industry jargon for companies that are actively exploring listing — has emerged in India. These dealers are witnessing a sudden rush in demand for startup shares from their clients in the secondary market.

Sandip Ginodia, CEO, Abhishek Securities, a firm that deals with unlisted securities, says apart from the sharp uptick in demand for such shares, his firm receives plenty of enquiries from sellers (ESOP holders) too. “If the demand and supply match, the transaction happens back-to-back,” he said.

The sellers are typically current or ex-employees and early investors while the buyers are investors targeting a startup.

A raft of startups such as One97 Communications, Paytm, Nazara Technologies, Mobikwik, Quikr, Oyo Rooms and Snapdeal, among others, are now listed on the website of some of the brokers who deal in unlisted stocks.

“The demand picks up if there is a fresh investment in a startup or if there is an intention to get listed. We get a query regarding Paytm (One97 Communications) almost every day since Warren Buffet announced his investment in the company,” Ginodia added.

Nazara Technologies is another startup in demand these days after the received market regulator SEBI’s permission to float an IPO. Nazara is one of the leading mobile games company, headquartered in Mumbai.

Altaf Siddiqui, managing director and CEO of Enrich Partners, another firm which deals with unlisted securities, said the ticket size for such deals ranges between a few lakhs and a few crores per transaction. “The list of buyers includes high net-worth individuals, family offices and also some retail investors who are willing to diversify their portfolio by investing in these lucrative startups.”

There are various methods being used for valuation of unlisted companies such as earnings multiples approach, discounted cash flow (DCF) comparing it with listed peers, etc.

These methods are certainly appropriate for mature companies or publicly-traded firms; but are much more challenging to apply to early-stage startups that have not yet generated consistent revenues, much less reliable earnings.

Siddiqui of Enrich, for example, said his firm uses a combination of valuation metrics. “The simplest metric is the DCF method but it has its own limitations. So we club it with other matrices such as valuation by comparable. We look at the valuation at which its peers recently raised fund etc.,” he said.

Siddiqui said price discovery becomes very tricky in the cases of unlisted companies, especially for technology startups because the business models are niche. “It is difficult to find a comparable peer for many tech-startups. In case of Nazara Technologies, there are no comparable peers in India in both listed and unlisted space."

"The closest comparable is China’s Tencent Games. We also look at comparable companies outside if we are not able to find one in India. We then make adjustments according to the difference in size of the companies, market size and market potential to arrive at a fair valuation.”

“Once we arrive at a fair valuation, then the actual price discovery happens through the usual demand-supply law. If there are more buyers for a particular startup share, price moves up and visa-versa,” he added.

Brokers also act as ‘market makers’ in many cases. “If we have a seller but no buyer is readily available and if they feel the startup has potential and the price is right, we buy those shares to sell it later at a higher valuation,” said the owner of a Mumbai-based firm which deals with unlisted securities.

Startup employees are understandably pleased with the demand uptick for ESOPs. “The liquidity provided by this secondary market is very helpful for employees to get a smooth exit at a fair value,” said an ex-employee of a fintech startup who recently sold his shares after his exit.

First Published:Oct 17, 2018 3:14 PM IST