Money For Nothin’ And Your ESOPs For Free

→ Startup CEO remuneration is a multiple of remuneration paid to the more steady, traditional, and profit-making businesses’ CEO compensation, an issue that corporate India is beginning to grapple with. As the companies list and private equity investors exit, these startup CEOs will have to meet the expectations of public market investors – which include generating returns, stronger governance structures, and tempered executive remuneration. Else, they are likely to set examples for shareholder activism in India.

Kruze Consulting, a US-based firm that provides start-up CFO consulting services, published a 2022 research report that showed that CEO salaries of startups increased by an average of 2.7% over 2021 to $150,000, which was a 7.9% increase over 2020 pay, during which CEOs took Covid-19 related pay cuts. As a result, start-up CEOs’ average remuneration is higher than pre-Covid levels and has increased over the 2019 peak levels. The 2022 research was based on CEO pay at over 250 seed and venture-funded start-ups.

The Kruze Consulting research also found that CEO salaries were linked to the amount of funding raised by the startups – the higher the capital raised, the more the CEO compensation. In 2022, chief executives at early-stage companies that raised over $10 million in financing were paid just under two hundred thousand dollars a year, $199,000. Founder CEOs at companies that raised under $2 million were paid $106,000 on average – a difference of over $90,000.

While the Kruze Consulting survey deals with relatively early-stage startups, the conclusion that CEO compensation is correlated to funding raising remains true for larger start-ups too, and even in India. Boards of listed start-ups can no longer operate as they did in the past – focussed on raising capital to support continuous cash burn. Being listed is not an endgame – it is the beginning of a new path, one that these companies need to transition into.

Most of the Sensex companies are profitable, and all of them have been profitable in at least one of the past five years: this cannot be said for the startups that have been listed.

One97 Communications (Paytm), for example, granted its Managing Director Vijay Shekhar Sharma 21 million stock options that can be exercised at Rs 9 per share in FY22. The fair value of stock options granted aggregates about Rs. 3,960 crore ($495 million, assuming the U.S. dollar at Rs 80). In addition, Paytm proposes to pay him Rs 4 crore (about $500,000) in annual compensation, with up to another 25% in perquisites (Rs 1 crore) in FY23. Zomato’s Deepinder Goyal, while having voluntarily waived his cash remuneration for 36 months beginning April 1, 2021, was granted 368.5 mn stock options in FY22 that can be exercised at Re 1, which at fair value aggregated Rs. 1370 crore(about $171.25 mn). Other start-ups like Policy Bazaar and CarTrade are yet to publish their FY22 annual reports.

Vijay Shekhar Sharma has publicly disclosed that his stock options will vest only once the stock price reaches the listing price – it has eroded by over 60% from the IPO price. This means that if IPO investors make back their losses and just get their investment back without any returns, Vijay Shekhar Sharma’s 21 mn stock options vest – assuming the stock price reaches the first day’s closing on BSE of Rs 1,564.15 (which itself is lower than its issue price of Rs 2,150), he will gain Rs 3,266 crore bn from exercising these at Rs 9. For Deepinder Goyal, it is unclear if the vesting of his stock options requires him to achieve a specified set of performance targets, or if these will simply vest over time – independent of his and Zomato’s performance. Deepinder Goyal has at least 10 years to exercise the stock options once they vest. If the stock price remains at the current levels through the vesting and the exercise period, he will gain Rs. 2,240 crore from the stock option grant, while IPO investors will have lost more than 50% of their investment.

For them, giving out these stock options results in limited dilution with no cash payout. Given the long association of the founders and the PE investors, there is perhaps some sense of returning to the founders their equity, which was diluted as they raised capital. But most importantly, ensuring that the CEO is focussed on driving up the stock price aligns with PE investors’ exit goals.

The role of PE investors in driving up remuneration is not limited to start-ups. In publicly listed companies like Sona BLW Precision Forgings Limited, EPL Limited, and Mphasis Limited, PE investors have encapsulated the leadership team into their exit goals – the senior leadership team, including the CEO, will get a share of the returns should the PE investors meet their exit return goals. This aligns the company with the PE investors' goals, which closer to the time of exit, may be short-term and not in the interest of all the company’s stakeholders.

Public market investors have been pushing back at the use of stock option grants to reward CEOs since these companies have yet to create shareholder wealth – stock prices have declined for most of them since listing. Yet, when presented to shareholders for approval, these resolutions pass – mainly because of the support of the private equity investors that remain vested after the IPO. Although most of the listed start-ups do not have promoters as defined under SEBI regulations, founders and pre-IPO private equity investors together hold dominant equity – thus driving these decisions.

The public market investors’ disappointment with startups has driven them to reduce exposure and fresh IPOs are almost a trickle. But if PE investors want an exit, these companies will need to attract the institutional investors back again, for which listed start-ups need to begin meeting the expectations of public market investors. Public market investors expect governance structures akin to those of other listed companies, a focus on generating returns, tempered executive compensation, and corporate behaviour that recognizes the role of a company’s stakeholders. The cosy relationship between the founders and the dominant shareholders will eventually end as PE investors exit, and the wider set of public market investors will ask a different set of questions. It is best they prepare to meet public market investors’ expectations now that they are listed, or else they are likely to set precedents for shareholder activism in India.

Hetal Dalal is President and Chief Operating Officer at Institutional Investor Advisory Services India Ltd.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.