Home / Companies / Start-ups /  Why are more startups reporting Ebitda before Esop costs?

NEW DELHI: Indian startups are increasingly reporting financial statements that do not strictly adhere to accounting norms, resulting in concealment of disclosures such as lost opportunity costs and equity dilution that could eventually reduce the earnings of investors.

For instance, many startups have started reporting Ebitda margins (earnings before interest, taxes, depreciation and amortization) before employee stock ownership plans (Esops) or ‘shared-based expenses’, which underscore their operational efficiency but does not account for Esop-related costs.

This means companies in their earnings reports highlight their operational profitability but not equity dilution—a practice that is frowned upon in the US. This is more common among startups as they tend to issue more Esops than traditional companies.

For instance, Paytm’s parent, One97 Communications said in August that its Ebitda (before Esop costs) loss narrowed to 275 crore in the June quarter, marking an improvement of 57 crore or 17% from the year ago. Paytm aims to turn operationally profitable (Ebitda before Esop cost) by September-end 2023.

Similarly, last month, hospitality and travel-tech firm Oyo claimed to have turned operationally profitable for the first time in the June quarter before accounting for costs related to its Esop grants. The SoftBank-backed company reported an adjusted Ebitda of 7 crore before ‘share-based expenses’.

Others such as Pepperfry and Zetwerk also recently reported their quarterly or annual Ebitda figures before Esop expenses, as reporting adjusted Ebitda becomes a common accounting practice, even if it doesn’t fall under generally accepted accounting principles (Gaap).

In the past, the US Securities and Exchange Commission has penalised companies for reporting non-Gaap measures without sharing proper disclosures to investors.

Oyo clearly disclosed operational revenue and net profit/loss as per Gaap in its June quarter results, a person close to the company said, adding that it reported additional performance metrics to give better understanding of the health of its business.

One such parameter is adjusted Ebitda to demonstrate its operational performance.

“Oyo didn’t include employee share-based expanse in adjusted Ebitda, primarily since it isn’t a cash expense. It highlighted what’s excluded and included in adjusted Ebitda and reported the employee share-based expense, should any investor want to include it in its evaluation," the person said.

Paytm and Zetwerk declined to comment while Pepperfry did not respond to queries.

A partner at one of the big four accounting firms said on condition of anonymity that both Ebitda and Ebitda before Esops are non-Gaap measures. However, since Ebitda is reported extensively, many think it’s a Gaap measure.

“Esop expenses are generally non-cash expenses and don’t impact a company’s free cash flow. However, firms need to be wary of the effect of dilution," said Sandeep Murthy, partner at venture capital firm LightBox.

A company eventually loses out on shares that could have been sold for cash in private or public markets. So, while issuing Esops, firms end up sacrificing an opportunity cost, which needs to be accounted for in their financial statements.

According to angel investor Prateek Toshniwal, who has backed three unicorns so far, Esop cost is usually included in ‘employee-based expenses’. “And according to accounting standards, all employee-based expenses have to be included in the revenue expenditure," he added.

Globally, several tech firms have been using Ebitda before the Esop metric since the onset of the internet boom, the partner said, adding that reporting of similar non-Gaap figures began way back in 2000. Non-Gaap measures typically exclude or include figures depending on what a company wants investors to focus on.

The partner said the consensus among investors, regulators, and company managements is that as long as such figures are relevant and are guiding investors, they are seen as useful indications of the actual business performance of an entity.

Companies are required to clearly define the non-Gaap metric while disclosing their financial statements. Time and again, regulators have issued contempt letters to companies that failed to provide explicit definitions of such metrics, the partner said. Ideally, a firm should also reconcile non-Gaap figures to Gaap numbers, show the adjustment, and explain the rationale for doing so, the partner said.

When asked if a metric like Ebita minus Esop could confuse investors in relation to a company’s performance, Murthy said investors need to understand how the company is valued. Murthy suggested that investors need to be smart while reading financial statements.

“Even if a company reports Ebitda profitability before Esops, investors should ask whether the firm will keep issuing more stocks to its employees and keep diluting them,’ he said. Also, in the longer run, if the company keeps issuing Esops, it could bring down earnings per share because of a higher dilution, Murthy said.

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