Why Is an ESOP Repurchase Obligation Important and How to Manage Them?
Over the last few years, the startup ecosystem in India has seen a rise in employee stock ownership plans (ESOPs) as a means of rewarding employees. After the funding boom of 2021, Indian startups increased their ESOP buybacks sharply in 2022.
Inc42 reports that fintech unicorns Razorpay, Pine Labs, CoinSwitch Kuber, and Cars24 bought back their ESOPs in 2022.
ESOPs are increasingly popular in companies as a way to offer their employees financial incentives, raise capital, and reward loyalty. In addition to that, ESOPs come with the obligation for the company to repurchase stock when employees leave.
Read on to find out:
- What is an ESOP repurchase obligation?
- Why is it important?
- How to manage it.
What is the meaning of ESOP Repurchase obligation?
ESOPs are designed to align employee and shareholder interests and provide employees with a direct financial stake in their employer’s success.
ESOP Repurchase Obligation is an agreement between a company and its employees that the company will repurchase or otherwise redeem shares of its own stock from the employees at a specific price.
How does ESOP Repurchase Obligation take effect?
This agreement is typically part of the incentive package offered to employees to encourage them to stay with the company and perform better.
The repurchase obligation typically comes into play when an employee leaves the company voluntarily or involuntarily, and the company must buy back the employee’s shares.
This ensures that employees who have invested in the company and worked hard are compensated fairly for their investment and efforts. The price at which the shares are repurchased is usually predetermined, typically at fair market value.
What is the importance of ESOP Repurchase Obligation?
In a statement issued in February 2023, data analytics company Tredence announced its second employee stock ownership plan (Esop) buyback worth $30 million (Rs 240 crore), providing liquidity options and wealth creation opportunities for the company’s top employees.
Some notable benefits of ESOP Repurchase obligation include:
- ESOP Repurchases provide companies with an effective way to retain their key employees by incentivizing them to stay with the organization.
- It provides an exit strategy for founders and early investors who want to liquidate their holdings without going public.
- It allows companies to use their own funds to buy back stock from employees and shareholders instead of taking out loans or issuing additional equity.
- It helps to reduce the dilution of existing shareholders’ equity.
- ESOP repurchase obligation helps increase the company’s market value by reducing the total number of outstanding shares.
How to Manage ESOP Repurchase Obligation?
To maintain a healthy financial position, the ability of an organization to manage its ESOP repurchase obligation is crucial. Here are a few steps you can take:
1. Have a repurchase policy
The first step is to have a well-defined repurchase policy which clarifies how the repurchase will be funded, who is responsible for calculating the repurchase price, how the repurchase price will be determined, and how long the company has to repurchase the stocks.
2. Establish ESOP repurchase reserve
This reserve should be funded with a portion of the company’s earnings to pay for the repurchase obligation. This reserve should be monitored regularly to ensure sufficient cover for the repurchase obligation.
3. Track the stock amount
The company should also monitor the quantity of stock held by its employees. If the amount of employee-owned stock exceeds a certain percentage of the company’s total stock, the company may be required to repurchase a portion of the stock to remain in compliance with the ESOP regulations.
4. Review the ESOP repurchase obligation
The company should also periodically review the obligation to manage it properly. This review should include an analysis of the repurchase policy, the repurchase reserve, and the amount of employee-held stock.
5. Regular communication
Finally, the company should communicate regularly with its employees about the ESOP repurchase obligation. This communication should include information about the repurchase policy, the repurchase reserve, and the number of stock employees hold. This will help employees understand the repurchase obligation and know their responsibilities under the ESOP.
Which factors can affect ESOP repurchase obligations?
Some factors can trigger the ESOP repurchase obligations, for example:
- Stock value: Recontribution/Recirculation of the stock in the ESOP against Redemption of Repurchased Stock into Treasury.
- Per share value: The value of outstanding shares rises after redemption.
- Tax savings: Using the recirculation approach, shares are purchased using pre-tax money.
- Contributions to the plan: How long will the employer make payments to the ESOP, and how much money could be contributed annually?
- Timing of contributions: Financing before distribution could lower repurchase costs overall.
- Loan repayment: How the loan is amortized, what the interest rate is, how shares are released from the suspense account, and other issues if the ESOP is leveraged.
- Demographics of the participant: Repurchase costs are influenced by employee age, retirement age, death and disability, and turnover.
Managing an ESOP repurchase obligation is an important task for any company offering employees an ownership stake. By planning ahead, budgeting appropriately, and tracking all repurchases, companies can fulfill their repurchase obligations and provide their employees with valuable retirement benefits.
However, repurchase obligations should be managed effectively by having an effective repurchase policy and monitoring financial performance closely.
To do this, companies can use new-generation ESOP compliance systems such as trica equity.
In trica equity’s one-stop ESOP management dashboard, startups and founders can manage their ESOP pools, policies, and grants from anywhere. In addition to customizing your ESOP, it also helps in keeping accurate records, reports, and diligence, as well as ensuring seamless integration with your HRMS.
Book a free demo to learn more about trica equity!