Waiting for appraisal? Here’s why many employers may offer ESOPs instead this year

Earlier in an internal note in February, CEO Gaurav Munjal had told staffers that Unacademy would give performance-based stock options instead of cash appraisals this year. This comes as the firm looks to turn profitable after multiple cost-cutting measures and layoff rounds amid a funding winter.

Meanwhile, tech behemoth Infosys allotted over 5.11 lakh equity shares to its employees eligible under two schemes this month. However, this was not in lieu of appraisals.

While one of the main aims of ESOPs is to retain top talent, the move comes with pros and cons for employees.

TeamLease Services CEO Kartik Narayan said the reasons companies offer ESOPs include employee ownership, retention and motivation, attracting talent, tax benefits and performance-based rewards.

"This appears to be a prevailing trend, particularly observed in startup companies, aimed at managing short-term cash flows while fostering long-term employee commitment to the organisation's success," he told CNBC-TV18.

According to Narayan, for companies, this strategy presents an effective means to conserve cash and navigate through the current global uncertainty and volatile market conditions.

He noted that given the emphasis investors place on value rather than mere valuation, it is prudent to exercise caution with cash flow to extend investments over an extended timeframe, as it may require several quarters for consumer demand and spending to rebound to sustainable levels for businesses. Additionally, this approach serves as a means to reward individuals who remain dedicated and assume responsibility for driving business profitability and value, he added.

Manish Khanna, Co-Founder of Unlisted Assets, explained that usually startups offer ESOPs as they are cash-strapped and are unable to attract experienced talent through high-paying salaries or appraisals.

He also pointed out that ESOP expenditure is a non-cash expenditure and a below EBITDA item in the profit and loss and offering ESOPs instead of appraisals makes the P&L and overall financials of the company look healthy.

- Teamlease's Narayan says the advantage of ESOPs lies in their ability to provide employees with greater long-term rewards by being associated with a successful business.

- By participating in an ESOP, employees gain a stake in the company they work for and this can create a sense of ownership and pride in the company's success, Unlisted Assets' Khanna said.

He added that as the company grows, so does the value of ESOPs, which can result in substantial gains in the value of employees’ ownership stake, providing them with significant financial benefits.

- Teamlease's Narayan explains that in the short term, employees may need to make compromises in terms of their day-to-day income and potentially forego certain immediate expenditures, as they await the appreciation of their ESOPs.

It is important to note that there is a risk of the ESOP losing all value if the company does not achieve success, which can be detrimental in terms of both current income and future profits.

- Moreover, ESOPs may not be easily liquidated, particularly for startups and early-stage companies that are not traded on readily accessible markets, he said.

- Putting it more simply, Khanna said, ESOPs can be risky because they are tied to the success of the company and if the firm performs poorly, the value of the stock can decrease, and employees may lose money.

Also, ESOP participants are typically heavily invested in their company's stock, which can make their portfolios less diversified, thus increasing risk and volatility, he added.

- Khanna also highlighted that in case employees are in need of money, it is tough to exit the vested ESOPs and get liquidity against ESOPs and that usually employees have limited exit options.

- Teamlease Services CEO suggests that to ensure fairness to employees, companies can adopt the approach of offering a minimum threshold price for the repurchase of ESOPs.

This option can be exercised by employees at the time of vesting.

“This mechanism aims to prevent employees from incurring significant losses while enabling investors to assume an appropriate level of risk associated with the employee's participation in the ESOPs,” he said.