The redBus sale: A cautionary tale
Bangalore/Mumbai: If you are the founder of a start-up or work in a start-up, then this story is for you. If you hope to ever go down that path, keep reading. Because what happened at redBus—yes, redBus, the whale of a start-up success story of the last few years—could happen to you.
To your company.
To your people.
And if and when that happens, then you need to know what to do.
Or what not to.
This cautionary tale, pieced together from interviews with multiple executives at redBus, investors and other people familiar with the matter, many of whom didn’t want to be named, begins in June 2013 when the bus ticketing website was acquired by the Ibibo Group, a subsidiary of South Africa-based media firm Naspers Ltd, for $135 million.
Back then, it was a big deal, a celebrated story. It still is. Except that within weeks after signing on the dotted line, the co-founder of redBus, Phanindra Sama, found himself in a rather humiliating situation.
It all started when he was feeling on top of the world, when he was on a holiday in London with his parents who’d never been abroad before. And since he wasn’t hoping to do any work, Sama didn’t care to get a local SIM card. So there was no one bothering him with calls or emails. That is till he landed in Bangalore. And switched on his cell phone.
In the 10 days he had been away, all hell had broken loose.
Goel wasn’t the only one who had resigned; three mid-level managers had, too. At the company’s headquarters in Bangalore, the scene was one of total chaos, of anxiety and anger— towards Sama, and Ibibo taking over. It had been just a few weeks, but employees were already feeling the team from Ibibo breathing down their necks. This was in complete contrast to Sama’s leadership style, which had been largely hands-off.
Work had suffered. Led by their respective team heads, employees from both the technology and product divisions were mostly huddled in conference rooms discussing what was happening. Questions were posed: “Why did Phani (as Sama is popularly known) cheat us? How could he do that?” “How many years have you worked at redBus? How much did you make from this sale?” “Do you know how much Sama and some other people in this company have pocketed?” “Do you know that in Infosys, even the car drivers made money?”
With Sama not around, the takeover team from Ibibo was foxed. Desperate calls and emails to him went unanswered. A simple thought was playing on their mind: now that Sama has sold the company, does he care? He must have seen this coming. For Sama, who has often been portrayed as the nicest man in the start-up world, someone who could do no wrong, this was a fall from grace.
Now, back in Bangalore, he couldn’t believe what had come to pass.
What had happened was pretty simple. With the sale of redBus, a few people, three to be exact, had become millionaires. A lot of people, roughly 600, did not. Except that some of them thought they deserved to. Their contention boiled down to a simple instrument, peddled ever so often in the start-up world—employee stock ownership plans (ESOPs). Those who had them couldn’t fathom why the money never showed up in their bank account. Those who didn’t have ESOPs were asking why not?
Back in office, Sama was clueless. He couldn’t figure if this was the same company, same colleagues he had left behind before going on his holiday. What he could make out though was that Goel had become the leading voice of the dissenting group. That left him baffled.
Throughout the run-up to the transaction, which lasted about two weeks, any disagreements that Goel and others brought to the table had been addressed satisfactorily. At least that’s what Sama and the Ibibo team felt (more on that later). Goel had even been promoted as COO just two weeks back.
The team from Ibibo wanted to tread carefully. Their trust in Sama had taken a beating so they asked him to take a back seat. While Sama could still be present in the meetings, Ashish Kashyap, CEO of Ibibo in India, would take over the task of managing the crisis. Several meetings ensued. In them, Sama steered clear of pointing fingers at specific employees and their motivations. Instead, he adopted a more emotional line: to address something that had hurt him the most—the accusation of having “cheated” anyone.
“Listen guys, you all know me,” he said in one of the town hall meetings, according to two people aware of what happened at the meeting.
“Many of you have been here for so long. Did you at any time feel this yourself? You leave (aside) cheating you or you cheating me. Did we ask you to cheat the bus operator at any time? Or even competition at any time. You all know how we have run this organization, how we have made decisions.” People didn’t look convinced.
Kashyap took over and tried to assure the team that Naspers was a global company and its policies or the way it would run redBus would be much different from the way in which Sama had run the start-up. “We will give you stock options, benefits and retention pay,” he said. “Whatever he (Sama) has done, let us put it behind us. Now, do you have any questions for Phani?” he asked, according to the two people cited above. A girl, sitting right at the end of the room raised her hand. “Phani, I want to know your side of the story,” she said.
Sama lost his cool. “There is no your side, my side of the story,” he snapped. “If you have any objective question, ask. Otherwise this will unnecessarily set off rumours.” The room went absolutely quiet. This was not the Sama employees knew. The nice man who almost never raised his voice had vanished.
But Sama got what he wanted. The audience left the room. No questions were asked. But they left wondering if Sama had really done it. Did he consciously deprive them of their stock options so that he could pocket all the money? Did he, on purpose, draft the employment contracts of senior executives like Goel and Gidugu in such a way that they wouldn’t see a dime? Why did the agreement not have an accelerated vesting clause? An accelerated vesting clause provides for employees to receive some or all of the unvested shares at the time of an acquisition or an initial public offering (IPO).
An ESOP is a benefit plan intended to encourage employees to acquire shares or ownership in the company. Start-up employees typically get lower salaries than those at large companies. But they are attracted to these ventures partly because of the possibility of profiting handsomely through stock options if there’s an acquisition or IPO. For instance, the IPO of IT services provider Infosys Ltd in 1993— when it was known as Infosys Technologies Ltd—resulted in more than 500 employees becoming millionaires.
Things were a bit different at redBus. Only the 22 top executives at the company had ESOPs.
The math behind ESOPs
A company typically reserves anything between 1-15% of its equity for ESOPs. “It varies from company to company,” says Mohini Varshneya, assistant vice-president at Corporate Professionals, a Delhi-based legal and financial advisory firm. “So, for public companies, it can be as low as 1%, but in start-ups, it is usually higher because you want more people to have ownership in the company.”
When redBus was founded in 2005, Sama had allocated 10% of its equity for ESOPs. And the ground rule for ESOPs is risk. So higher the risk, higher the equity offered. This means that people who come on board early get more. Those who join later, get less. Between the time redBus was founded, in 2005, and its acquisition in 2013, the company had already issued 6% of its ESOP pool. To put this in perspective, imagine a situation where you are eight years old in the company and 6% is already gone. You are left with 4% and you don’t know how long the company’s life cycle is. Let’s for a moment assume 30 years. To put it simply, that’s 4% for 22 years.
For an eight-year-old start-up, to have consumed 6% of its ESOP pool is “fair”, says Varshneya.
She adds that in nine out of 10 cases, companies give ESOPs to people who are directly linked to the organization’s growth. “Inevitably these are people at the top,” she says. The lower you go down the corporate ladder, the more it is about cash in hand and not ESOPs. In 2013, redBus employed about 600 people. Of this, 250 were call centre executives. Another 100 were employees in the field dealing with bus operators. About 150 people were in product, technology and marketing. Of these 150 people, 22 had ESOPs. That’s roughly 15%. Some companies give ESOPs to more employees and some to fewer. Again, there’s nothing unusual about the number.
While the numbers tell a black-and-white story, events turn a shade grey when it comes to the ESOP agreement offered by Sama to the top management. And more specifically, what transpired between Sama and the dissenting employees, particularly Goel, in the two weeks preceding the sale of redBus. To understand this, a bit of history should help.
Goel joined redBus in late October 2012. In his earlier assignment, he was based in the US working at Google Inc., where he was the global product management lead for Google Display Network and was responsible for the relaunch of Google’s ad product, AdSense. At the time of relocating to India, he had another offer from e-commerce retailer, Flipkart, but chose to go ahead with redBus instead—at a significantly lower salary. He took the pay cut because of the ESOPs. Plus he was given to believe by Sama and the board that here was a company that could make him a millionaire, whenever it went public or sold out.
Goel’s ESOP scheme, like those of the other 21 other redBus executives, was structured in a way that 10% of an employee’s options would vest after the first year, which means an employee is eligible to convert his/her options into redBus shares at a fixed price after spending a year at the company. As per the scheme, 20% of an employee’s options would vest after the second year, 30% after the third and 40% after the fourth. According to Varshneya, there is nothing odd about this vesting schedule. “Companies want employees to stick on longer, which is why a large chunk of the payout is the fourth year,” she says.
Sometime in early June 2013, eight months into the job, four months before his first vesting would be complete, Goel got to know that Sama was selling redBus to Ibibo.
The road downhill
Two weeks before the transaction was publicly announced, Sama broke the news to his top management executives. They were shocked. redBus had been in the market only to raise funds and some of these executives, including Goel, had made presentations to potential investors. The thought that redBus would be sold hadn’t even occurred to them. People were not happy. More so when they were told that they wouldn’t be making money from the deal. A lawyer’s opinion was called for, but they were told that the proposed sale wouldn’t trigger accelerated vesting of their ESOPs. Now, they were really miffed.
It would be fair to say that Ibibo’s Kashyap and Sama had anticipated this, somewhat. Kashyap, particularly, was keen on retaining the senior management. But giving them cash was not an option. They could take it and leave. Instead, he offered salary hikes of at least 50-60%, stock rewards in Naspers and retention bonuses. The retention bonuses were equal to the value of the ESOP agreements, only that the payment would not be made as and when the options vested, but at the end of the financial year in which they vested.
And then there was Goel’s promotion. Ibibo told Sama that they were looking for a new COO. Since Sama would have to exit the company at some point within the next two years, a COO should come in early and pick up the ropes. Sama thought it would be a good idea to promote Goel. Sure Goel lacked the experience, having worked at the company for only eight months, but he deserved the chance. The team from Ibibo was not very sure, but Sama persisted. Goel himself was up for the assignment when Sama reached out to him with a revised offer. Sama spent the next few weeks trying to push Goel’s case. Promoting a person less than a year old in the company would involve a change in reporting structure and could rile a few who had spent more time at the company.
As expected, some employees protested. Sama figured a way around this problem would be to meet all the people individually and try and convince them. But that would need more time. Goel was getting impatient. Another week passed. A day before leaving for London, Sama announced Goel’s promotion, which had been effected weeks earlier, in an email.
Less than eight weeks into the position of COO, Goel resigned. And then, along with Gidugu, he got chatty with a lot of people to share why he had done it. From there, it was all downhill.
A former senior redBus executive who spoke on condition of anonymity claims the accelerated vesting clause was very much there in the ESOPs agreement. Accelerated vesting happens if it is a merger and the new employer does not give any ESOPs or if the new employer wants you to leave because he feels there is no role for you.
“But if the employer is saying, stay, if the employer is giving you his own ESOPs, then there is no need for accelerated vesting,” the executive says. “It is not like anything happens and you get accelerated vesting. People like to believe that if ownership in a company changes, then accelerated vesting should kick in. You may believe that but it is not true because this is not what was written in the document, when we signed on the dotted line.”
It didn’t end well, did it?
“There were interpretation issues, ‘I said, you said’ issues (with the ESOPs),” says Parag Dhol, a former board member at redBus and a partner at Inventus Capital Partners. “I wouldn’t say the employee grievances were silly or did not deserve a second thought. Between the parties on the table—the investors, the buyers and the co-founder—we could have coordinated and handled the issue better. It’s a personal lament. But there was no violation of the terms of the (ESOP) agreements.”