Esops-The great reluctance to cash out
Esops help in retention and wealth creation, but a behavioural reluctance prevents many employees from selling company stock, even when it creates dangerous concentration risk in their portfolio.
Employee Stock Option Plans (Esops) are a potent tool to ensure that the key employees stay and grow with the company. With startups, the Esop value is notional, meaning it is unlocked only when the company goes public or a buyer is willing to purchase the unlisted shares. If the shares are listed stocks, the wealth potential is real.
Esops are a great wealth creator, especially when one is getting regular allotments, which helps build good positions over time. While the positives exist, there are certain things to keep in mind regarding Esops.
Esops can be a concentration risk
Many have substantial holdings in Esops, which become the most important asset holdings by far. High concentration of one company's shares can be dangerous in a portfolio, and hence, trimming the Esop allocation may be the right thing to do.
However, most people (who have the option to sell the shares) do not agree, especially if the Esop shares are doing well. They reckon that holding on to the shares would be in their best interests.
However, we have seen in multiple cases that what looks bulletproof at one point becomes vulnerable and erodes in value due to multiple reasons like competitive intensity, change in industry dynamics, slide in company performance, macroeconomic/geopolitical factors, etc.
Anchoring bias
Once the Esop share values slide, the holders still do not want to sell as the share has seen “better days" and they will wait for the share price to again recoup to the previous highs.
It hardly makes an impression when financial advisors caution them that the share prices have come off the peaks for a reason, and it may be a good idea to sell some portion to diversify holdings.
In fact, many continue to buy Esops without a care. That may be putting good money after bad, increasing portfolio concentration.
Performance will catch up
Over time, many “marquee" companies have delivered middling performances that fall below the benchmark. We observed this phenomenon in the case of an Indian retail company, whose five-year performance is lower than that of the Nifty 500 index. However, for the Esop holder, this does not count for much, as their Esops are still generating substantial returns in rupee terms—their buying cost versus the current market price.
This is, of course, no way to look at returns. Yet due to the behavioural quirk where people want to feel good about their decision, they want to believe that they have indeed made a great investment. This also happens with properties, where the rupee appreciation is celebrated without understanding that the compounded growth is average to poor.
Company is a good one
Some are convinced that the company they work for (whose Esops they hold) is a good one. This conviction encourages them to stay invested, even when the shares are not performing well for extended periods.
These shares are treated like family silver, while sometimes that family silver had turned into bronze a long time ago.
Employee with equity
This increases the risk as any adverse effect on the sector or the company will affect both the individual who works and owns shares in the same company.
It is prudent to reduce one’s holdings in the company to reduce this risk.
Holding onto gains
When the Esops are doing well, there is a great reluctance to sell. There is always a market pundit who predicts that prices will rise even higher. When the prices do touch the higher watermark, there is an even higher “guidance" by market mavens! This is now happening with AI-oriented companies whose valuations are in the stratosphere.
Due to this, many people find it difficult to sell even when the Esops they hold are doing quite well. They do not understand the risk they are exposed to, as a substantial portion of their wealth is riding on one stock. If it falls at some point, anchoring bias takes over as discussed earlier.
Counting chickens not hatched
There are a substantial number of people working in startups whose shares are unlisted. The share prices are notional, and there is no price discovery. The only discovery is when a VC infuses money at a certain deemed valuation.
There is nothing that such Esop holders can do, except hope for a listing in the foreseeable future or a stock dilution possibility through the sale of their holdings to another entity that wants to come in.
Considering the high attrition rate in startups, the awesome value of shares they hold remains largely on paper.
In summary, it is essential to evaluate Esop holdings and seek professional counsel on retaining or selling the shares, considering the risks one is exposed to. Often, the risk is substantial when everything hinges on the value of Esops. Time for a reality check.
Suresh Sadagopan is the MD & Principal Officer at Ladder7 Wealth Planners and the author of the book “If God Was Your Financial Planner"
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