In a recent report, global brokerage firm Jefferies looked at employee stock option (ESOP) expenses by food delivery firm, Zomato. The firm was evaluating its stance on the stock, for which a significant concern among investors and analysts has been its costs and “Adjusted EBITDA” metric.
For the uninitiated, Zomato went public in 2021, the bull market, by raising Rs 9,375 crore from its initial stake sale by offering shares at Rs 76 each. The stock made a record peak at Rs 161.60 in late November 2021. The stock is currently trading at about ~89.7% below its all-time peak and ~14% below its issue price.
Adjusted EBITDA is the company’s earnings by adding back interest expenses, taxes, depreciation charges, and other metric adjustments. It also includes ESOP costs that the company considers as non-cash remuneration. At every new ESOP pool and grant, these expenses rise and, thus, affect the company’s net profit/loss.
What is ESOP Expense?
When a startup offers ESOPs to their employees as part of a compensation plan for their services, a cost to the company is incurred (not in cash but in kind). Therefore, ESOPs are considered an expense in the company’s accounting books. But these ESOP expenses have no direct impact on the operating performance.
Startups registered in India should comply with Indian Accounting Standard 102 (IndAS 102) to report ESOP expenses as the Institute of Chartered Accountants of India (ICAI) recommends. IndAS 102 establishes uniform accounting principles and practices for all types of share-based payments toward employees and non-employees for Indian companies.
Zomato’s ESOP Expenses
In the case of Zomato, the company granted ESOPs under three pools, created in 2014, 2018 and 2021. When fully exercised, these cumulatively make around 900 million shares at an 11% dilution. As of March 2022, 80% of this ESOP pool was granted, while the rest was available for future grants. Around 504 million shares, i.e. 70% of granted ESOPs, were still under the vesting period, and costs for these were getting booked in the profit and loss statement (P&L).
The company sees a significant difference in its P&L statement with every new ESOP pool and grant, as you can see here.
It is also important to note that ESOP expenses are part and parcel of a startup’s growth journey considering they help a lot in hiring senior talent and retaining employees. However, this perpetually recurring activity is highly cumbersome and error-prone when done manually over spreadsheets. Hence, we introduced ESOP expense reports to manage such expenses.
Being a decade-old publicly-listed business now, Zomato has almost used its ESOP pool. The Jefferies report noted, “New grants are declining sharply, and Zomato is no longer a startup that needs to rely on ESOPs overly. The existing pool seems sufficient for several years.”
It also stated that further ESOPs would need more than 75% shareholder approval, and investors will have a decisive say. Thus, promising that as the company grows, these expenses will settle once the vesting of older ESOPs is complete.