Thursday, May 31, 2012

Time and me

एक फितरत और देखि वक़्त की
खामोश हैं पर मुस्तैद हैं
खुशियाँ उडाऊं तो पकड़  ले
अश्रु गिराऊं तो चुन ले
सब कुछ समेत लेता हैं
मैं उडूं तो यह दौड़े
मैं ठहरूं तो यह थमें
एक मुकाबला करता हैं |

संग  इसके खेल में ,थोडा हुनर सीख लिया
इस के कुछ  रहस्यों को भेद दिया
इसके कुछ दिनों को छुपा दिया
कुछ रातों की बाहों में  खेल लिया
लम्हे थे कुछ इसके, नाम अपना लिख दिया
जब जब इसकी सरहद को न पार कर सकें
इसे लफ़्ज़ों  में गिरफ्तार कर लिया |

These lines were written expressing a different perspective for a few lines written on time by a friend.

Anuj Lakhotia

Tuesday, May 22, 2012

Equity Compensation - Things to consider

If you have been bitten by the start-up bug and are considering equity offers from start-ups, read on.

1.       Equity or Esops
Equity differs from Employee stock options as it makes you a stockholder, eligible for dividends and makes you a participant in certain decision making.

Employee stock options convert to shares only after the options have vested and you have exercised your options.  Options have a minimum vesting period of one year as per SEBI guidelines.

Ideally, founders are granted equity or Restricted stock units (RSUs)- equity that is granted after certain restrictions like performance, time spent are met. RSUs can be optimized for taxes when granted at par value.  Companies are reluctant to offer this as it comes with an increased overhead of an extra stockholder and other legal requirements like an escrow etc.

Exercising the options includes paying the exercise price and a tax payment. In India, a perk tax is charged as per your income tax slabs on the notional income earned by the appreciation of the underlying shares.

Ideally, the exercise value should be at par value for employees to reap benefits of share price appreciation. 
Late stage investors often ask for an additional optional pool to be created for newer employees and may keep the exercise price at the investment price.
Find it out if the company is willing to pay the taxes else the employee will have to bear this. This can be quite significant and you would be paying taxes on unrealised income. The guidelines are not clear if the loss can be adjusted in future taxes if the shares never become liquid.

Also note that the holding period for capital gains for RSUs starts at the day when you get them. The holding period for shares earned via stock options start only after you have exercised the options.

Options also have an expiry period before which they need to be exercised. A standard norm is ten years.

2.        Grant period and vesting schedule
The stocks come to employees at a given vesting schedule.  Every year you get a proportion of your total equity grant as defined by the company Esop policy document

A standard norm for early stage companies is equal vesting (25% of total stock granted) across first four years of service. Late stage companies have a shorter vesting cycle as they are expected to be closer to a market exit.

Early to growth stage company can have a bigger proportion (say 50%) coming in the first year and remaining divided equally across the cycle.Companies can form one single scheme for all employees or multiple schemes.

The vesting dates are important as it gives you access to equity for RSUs or a right to exercise the option in case of esops.Your options can vest to you on a monthly or an annual basis.

 A good norm from an employee perspective would be to have a “cliff” of one year for the first vesting and post that the vesting to be monthly or quarterly.

3.       Number of shares, Percentage stake ,Valuation and Exit returns

It is important to know your total number of shares as well as the percentage equity stake.

Angel funded or early stage companies often do not have good benchmarks to establish share prices. They may use aggressive revenue multiples on aggressive revenue targets to make the offered equity valuation look attractive.

It is important to understand the business plan, key metrics before agreeing on such numbers.

Early employees and significant contributors can ask for a higher percentage stake when negotiating for their overall remuneration. There is a higher risk for early stage companies than growth stage companies and hence a prospective employee should accommodate for the same. One should research the norms for equity grants for his/her role.

Once the company has an exit, often the venture investors are returned the invested amount first (preference clause) and later the returns are divided among all the stockholders ( this may include the venture investors). For start-ups that do not generate stellar returns this shall further dilute the returns of an employee.

4.       Impact of "Liquidation/Funding" events

Employees who are given common stocks will have their stake diluted in the company if fresh shares are added to new investors. E-commerce companies generally have longer gestation periods and may raise as many as five rounds of funding – the percentage stake dilution can hence be significant.
Certain class of shares may have a clause to have a proportionate fresh shares issued on any new share addition to keep the percentage stake from going down.

Investors often have a preference clause and a participative clause for next rounds of funding. This may give angel investors a way to exit their investments to later stage investors.

Esop Policy document also may have obscure "clawback clauses" which gives company/investors the right to purchase  the shares back from an employee.The Policy document also has guidelines if the employee can sell his shares to external parties. Also, guidelines on how the stock sale may happen if the company goes for an IPO.

5.       Impact of "Change of control" events

Often cash strapped start-ups get merged/acquired by other companies or key founders may leave. In such cases, the role of an employee may not remain the same as management control changes. Few employees may also be forced to leave the organisation. In such cases, there should be a provision for accelerated vesting
Standard norms include “Single trigger” acceleration of atleast one year on change of control.
“Double trigger” acceleration includes multiple events such as change of control and employee firing. In such cases all unvested shares should vest immediately .

6.       "Grace period" and ability to take the stocks post termination of employment

Grace period is the time post termination of employment in which the employee can exercise his vested options to convert them to shares. This gives employee time to generate funds for paying the taxes or the exercise price. If the stocks are listed on the markets, then the employee can exercise the shares depending on the market performance.

This can be normally from 3 months to one year.  An employee should be able to take his stocks with him post termination of employment.

I am also new to this and I write this after having received 2 such offers and working at one e-commerce start-up. Several posts on  have helped me understand this aspect of start-up world. Please feel free to share your suggestions.

Anuj Lakhotia