Finance

Crypto Scare: Is the Hype Settling Down?

by Sandeep Kumar

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Crypto Volatility Index (CVI) hit a near one-year high of 127.03 on May 12th. The value of Coinbase, a big bitcoin exchange, has plummeted. A cryptocurrency that advertised itself as a reliable medium of exchange has gone bankrupt. A drop in cryptocurrency values has wiped away more than $300 Bn. The decline in cryptocurrencies is part of a broader shift away from riskier assets, which has been fueled by rising interest rates, inflation, and economic uncertainty resulting from Russia’s invasion of Ukraine. These reasons have exacerbated a “pandemic hangover” that began when life in the United States began to return to normal, damaging the stock values of companies like Zoom and Netflix, which profited during the lockdowns. However, crypto’s collapse is more severe than the stock market’s overall decline. While the S&P 500 has lost 18% this year, the price of Bitcoin has plunged 40% in the same time. Bitcoin has dropped 20% in the last five days alone, compared to a 5% drop in the S&P 500. Let us have a look at the kind of impact the crypto slump is creating on various stakeholders.

How the fall of TerraUSD and Luna has created panic?

The crypto shock occurred primarily after the sudden crash of the stable coin TerraUSD and Luna token. For the past six months, investors bought UST in order to profit from Anchor, a borrowing and lending platform which offered a 20% yield to anyone who bought UST and lent it to the protocol. The idea was criticized as it was likened to a Ponzi scheme which would not be successful. Karma hit the founder, Do Kwon, hard enough who is known for calling out critics as “poor”. Former Terra employees and retail investors in the crypto are holding the Kwon responsible for the losses. While he is still optimistic about his plans to revive Terra, Kwon is facing some major backlash in the form of lawsuits, fines and penalties.

Since May 10th, when TerraUSD and Luna began to show indications of difficulty, cryptocurrencies used by South Korean gaming firms for in-game purchases and trading have experienced erratic trading. As of then, C2X, which formerly used TerraUSD as its main platform thanks to a collaboration with Terraform Labs, the firm behind TerraUSD, which is now depegged from the US dollar, was trading at roughly 1,000 won. According to industry officials, game firms with products that include virtual coins and other blockchain functionality are still on high alert due to the recent collapse of the TerraUSD and Luna cryptocurrencies.

Wemix, a cryptocurrency run by Wemade Co., the maker of the play-to-earn game “MIR4 Global,” dropped by 28 percent during the TerraUSD fiasco before recovering back to the 2,700 won level on May 16th. MBX, Netmarble Corp’s virtual currency, has also plummeted by more than 80% to roughly 11,000 won, compared to around 64,000 won on May 6. Klaytn, a blockchain platform established by internet behemoth Kakao Corp., was also down to roughly 500 won, down from over 650 won on May 10th. Companies are keeping a close eye on the newest developments and concerns in the Bitcoin market in general since a loss of user and investor confidence might jeopardize the gaming industry’s Blockchain ecosystem, which many companies have already extensively invested in. Several crypto exchanges including Coinbase, Binance, Coinswitch Kuber, CoinDCX, even temporarily delisted Luna coin.

Sector euphoria that fueled the NFT boom has given way to more pessimistic conditions, forcing the mostly speculative NFT market to face reality. NonFungible, an NFT data business, stated that transaction volume was down 47 percent in Q1 2022 compared to the previous quarter. The figures are even more dramatic when looking at daily average sales, which fell by 92 percent between September 2021 and April 2022. Such challenges are far from insurmountable. For an NFT market that has been weak on value proposition but strong on hype, a washout was always going to happen. This data will be seen by critics of NFTs as the beginning of the end for projects that have been marked by over-promises, rug pull scams, and flash over substance. A reduction in speculation is more likely to refocus entrepreneurs on adding clear value to digital assets. A more clearly defined use case with a highly motivated and well-capitalized stakeholder to assist drive forward development is required to propel innovation forward.

What to expect in the longer run?

The fall of USDT has reflected poorly over the entire stable coin industry. Developers created functional and safe algorithmic in order to make it less susceptible to government oversight and more resistant to inflation than fiat-backed stable coins. However, they have lost their peg and failed. Some crypto analyst even suggest that the idea of algorithmic stable coins will now be put to rest. On the other hand, despite the volatility in the crypto industry since the beginning of 2022, private equity and venture capital investment into the crypto and Web3 space have been optimistic. The recent shocker has led Terra’s major investors to decide whether to help bail the project out or pull back and escape. While Lightspeed Venture Partners, one of the investors of Luna token, is planning to double down specifically in infrastructure, DeFi and emerging use cases, there is a possibility that the DeFi hype may now calm down. Until economic growth and corporate earnings forecasts are altered, there will be a sluggish flow of fresh money into equities, commodities, bonds or cryptocurrency markets in the coming months.

The arising concerns due to the crashing crypto market have been drawing attention to the regulation of cryptocurrencies. From USA to India, public officials are calling out the need for a regulatory framework to guard against the volatility risks of crypto. The US Treasury Secretary Janet Yellen has called for stable coin regulations to mitigate the risks, ensuring there are no gaps in the regulation. In India, experts are in a process to lay out tax policies for cryptocurrencies. However, naysayers believe that it could disturb the huge potential that the crypto industry brings in terms of intersection of blockchain, machine learning and job creation. Lack of clarity on policies is discouraging innovation in the sector and forcing job seekers to look for opportunities outside India where there are more crypto friendly policies.

A wake-up call for investors

There is no doubt that crypto is a volatile space. The crypto market has survived all this due to the underlying premise that the blockchain is a powerful tool that can change the way the next generation of digital products is built. However, some investors try to make quick money out of these volatile markets. Several people lost their entire life savings through crypto investments. It is advised that investors should research the projects, the technology and promoters before investing in tokens and not just follow returns blindly. Shocks like the recent one will act as a wake-up call and likely make investors mature. As per Sidharth Sogani, founder and CEO of Crebaco Global, a rating, research and intelligence firm focused on blockchain and crypto, more trouble is yet to come. He mentions that as for the crypto market is concerned, we might see a further down or a sideways movement for the next three to six months before it enters the bull market again.

So next time you make any investment decision, especially in a volatile market like crypto, be sure to be patient and do extensive research instead of running after quick returns.

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This article has been co-authored by Sayan Mitra and Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

Valuation Reset: Who are the gainers and losers?

by Sandeep Kumar

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From a year of record funding to valuation check, how have things changed?

For any startup, raising funds is an inevitable part of the journey, and it highly depends on how the company is valued. VC funding sky-rocketed in 2021 with over $643 Bn going into global venture investment. This marked a 92% growth compared to the previous year. Consequently, we witnessed more than 10 new unicorns being minted each week on an average, adding around $1.8 Tn in value.

The amount of funds that went to higher-risk, early-stage startups was notable in 2021 as it witnessed almost 100% YoY growth in early-stage funding, with $201 Bn in about 8,000 startups. However, the good times do not seem to continue in 2022. Often, startups overvalue themselves in order to raise funds without giving up much of their equity. This may be detrimental in the long run — in case the company struggles to meet the expectations of the investors, it will have to raise funds at a lower valuation in the future rounds. Moreover, external factors like geopolitical tensions, inflation, underperforming IPOs and public markets have also affected the startup valuations. Through this article, we try to understand the different reasons for the decline in valuations and the kind of impact it could have on investors and startups.

Source: Crunchbase

Valuation reset for overvalued tech unicorns

After the hyped market in 2021, venture capitalists are now renegotiating their deals. As reported by WSJ, Tiger Global Management which has been one of the most prolific startup investors is renegotiating the investments for several companies, reducing the valuations by more than 20%. Manhattan Venture Partners also noted a nearly 10% plunge in the stock purchases of certain private companies in the first month of 2022. Some high-growth startups are even scaling back the funding rounds or delaying their IPOs that could value them lower than expected.

Let’s have a look at some recent examples where startups have been revalued by the investors or have themselves reset their valuations.

  • Philadelphia-based growth startup, Dbt Labs Inc, scaled back its funding round that valued it at around $4 Bn instead of the initially negotiated $6 Bn.
  • Fidelity, which has an investment in fintech giant Stripe, recently marked down the value of the company by over 9%.
  • The delivery giant, Instacart slashed its valuation by about 40%, valuing the company at $24 Bn down from its earlier valuation of $39 Bn.
  • Startups like OYO and Pharmeasy, who were preparing to go public are now considering downsizing their IPO valuations considering the market conditions.

The effect of tech sell-offs in public market is also visible in the private secondary market as there is a heightened interest in selling shares at a discounted price, typically 10% — 30% lower than the last quarter of 2021. With fewer IPOs, shareholders are looking for liquidity solutions in the secondary market, ready to sell their shares at a discount.

VC pull-back and a shift in focus

As market correction started happening in the public markets, its effects have been trickled down to the private market as well. As a result of huge tech sell-offs and dropping valuations in the public market, many VC firms have tightened their grip on startup funding as well. Investors are rechecking the startups’ valuation at a lower level to account for the pressure on the public peers. Firms like Tiger Global Management and D1 Capital have pulled back from investing in late-stage startups. The growth stage and later-stage funding seem to be stagnated. At times like these, some startups may be in desperate need of raising funds, so they will have to lower down their valuation expectations to be able to raise some cash. Meanwhile, startups that had raised huge rounds last year are being advised to use their funds wisely and prepare for even worse times.

The plunging tech stocks facilitated by inflationary concerns and rising interest expectations added to the pessimistic lending behaviour. The stocks of public companies, which typically guide the valuation of startups, saw a decline in valuation. By the end of January, companies that went public last year were down an average of 32.6% since their listings. Less proven companies performed even worse. Not only did the drop hold back investors, but also delayed the startups from going ahead with the IPO. The reset in startup valuations was well predicted, but what is surprising is that historically there has always been a long lag in the private market’s reaction to a public market slowdown, now it’s much faster.

However, things are not the same for all the sectors. While consumer businesses have taken more brunt of the pullback, companies dealing with blockchain, cryptocurrency, and cybersecurity have continued to attract VC interest. Despite the tight funding hand, investors’ focus has been shifted to seed and early-stage startups. The risk may be high with early startups and they are far away from taking a meaningful exit, but they allow investors to write smaller checks that could still give them some returns.

How is the valuation reset going to impact the stakeholders?

A drop in valuations is a double-edged sword. Investors may welcome the dip in valuation as it would mean that they would get new deals at a meaningfully lower value. VCs would love to offer lower prices on new deals, but also want their existing portfolio companies to be marked up in subsequent rounds. There is also a significant chance that the public companies, that guide startup valuations, will normalize back to the mean of the last couple of years. Consequently, VCs have tightened their lending capacity and shifted their focus to early-stage startups. Many startups had raised huge amounts for the early rounds, which raised the expectations and hence the valuation of the company. Now, slashing their valuation in order to raise funds would mean that startups will have to dilute a greater chunk of their equity.

The kind of valuation reset that we have started to witness was much needed after all the craziness in 2021. However, whether this is just a minor correction or has a long-term impact is difficult to determine now and we will have to wait and see at least till Q2 or Q3 of this year to understand where this goes. Till then, startups need to utilize their available cash prudently.

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This article has been co-authored by Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

Is the Chinese Stock Market a Safe Haven for Chinese Tech Companies?

by Sandeep Kumar

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Chinese Stocks Performance

Most Chinese tech companies listed in either the U.S. or Hong Kong experienced a disastrous wave of panic selling, pushing prices to a record low. The Hang Seng China Enterprises Index, which tracks Chinese companies listed in Hong Kong, underwent the biggest drop since November 2008. Analysts have termed this drop to be “scary” even in this extremely volatile market. The Index was down by 7.2% on 14th March 2022 and another 6.6% drop on 15th March 2022.

After a solid performance in 2020, most overseas-listed Chinese tech companies have been on a constant decline in the last year. The market cap changes from February 2021 to March 2022 have been immense for the 11 largest and best-known Chinese tech companies with Alibaba’s market cap slashed by 66%, Tencent by 50%, and PDD, the rising e-commerce platform, by 82%. Several notable names fell by double-digit percentages — JD.com by 7.14%, Hello Group by 5.74%, Baozun by 10.43%, iQIYI by 16.74% and Zhihu by 16.14%. The MSCI China Index has seen its valuation more than halve from a Feb. 2021 peak. The gauge is trading at about 9 times its 12-month forward earnings estimates, versus a five-year average of 12.6

Recently, JP Morgan Chase downgraded several Chinese tech stocks starting with JD.com, China’s largest direct retailer, from overweight to underweight and slashed its price target from $100 to $35. This was in harmony and came in as a response to valuations falling in the sector as well as due to a tougher macroeconomic environment.

Reasons for Plunge in Chinese Tech Stocks

The recent plunge in Chinese tech stocks has been such that investment banks like JP Morgan Chase and Goldman Sachs is now calling Alibaba, Tencent and Meituan “uninvestable” over the next 6 to 12 months. Russia-related risks, the domestic spread of Covid-19, and strong market regulations are apparently the biggest contributors that have caused this downfall in the market.

Firstly, among the geopolitical stress between Russia and Ukraine, the US and other European nations would impose sanctions on China, which would further squeeze the economy at a vulnerable time. Secondly, China has shut down the tech manufacturing hub of Shenzhen for more than a few weeks to combat the domestic spread of the Covid-19 virus. Even though this might not have a direct relationship with the performance of the stocks, it leads to supply chain and geopolitical concerns that drive manufacturing away from China and could pose itself as a weight on the Chinese economy. Lastly, a spate of recent regulatory developments is making traders wary of investing in Chinese stocks. Tencent Holdings Ltd., the owner of the super app WeChat and one of China’s biggest tech companies, has been facing a large fine for violations of China’s anti-money laundering rules, which has pushed the stock down by more than 10%.

A plunge in Chinese technology stocks slid after the US Securities regulator played down the prospect of an imminent deal to keep local firms listed on the American Exchange. The Securities and Exchange Commission identified several Chinese firms which face the risk of being delisted from the US, as a part of a crackdown on foreign firms that have refused to open their books for scrutiny to US regulators. The SEC added Baidu Inc. to their list recently for barring audit disclosure. Despite all these reasons, certain analysts view that Chinese tech stocks are no longer profitable. Investors are on a thirst for returns and it has become much harder for such companies to display green bottom lines as they are constantly being squeezed by regulations, domestic economic slowdowns and other political factors. Moreover, the macroeconomy has become weak, particularly domestic consumption and as these companies operate in Mainland China, the lack of consumer demand is hurting them constantly.

Measures to boost Chinese market and the rebound of Chinese tech

Stock prices in Hong Kong and China showed significant rebound in their performance after China’s State Council promised to drive the financial markets by easing certain regulations on technology companies, providing support for property developers and overall, boosting the entire economy. Following this announcement, China’s benchmark CSI 300 Index gained 4.3%, Hong Kong’s Hang Seng Index jumped 9.1% and the Hang Seng China Enterprises Index surged 12.5%, in March 2022. It also shot up the share prices of China’s two largest tech companies, Alibaba Group Holdings and Tencent Holdings, by more than 20%. We are seeing clear structural changes in China’s industrial policies and regulatory stance, especially within the tech sector. In the short run, it might have caused pains in the form of slower growth or increasing costs, but it has helped to create long-term benefits such as healthier competitive environment, higher ESG standards, and ultimately, more sustainable growth. Investors also got an optimistic signal when the Chinese Vice Premier held a meeting to stabilize the capital market and asked for more coordination and restraint from regulatory crackdowns, which instantly led to the rebound of these stocks. Big brother, “Beijing”, tried to calm the panicking stock market with this meeting and urged other government agencies to coordinate with the financial regulators before announcing measures that could disrupt the market.

Is Chinese market a safe place for Pre-IPO companies?

Beijing is currently stepping up its oversight on the flood of Chinese listings in the US, which are mostly tech companies. The State Council also announced that the overseas listing rules for domestic companies will be made even stricter and will tighten restrictions on cross-border data flows and security. The crackdown on tech is a common trend and market analysts view that it could not only threaten the IPOs in the pipeline but could also pressurize the popular Chinese ADR market. Chinese regulators are eyeing a rule change that would allow them to block a domestic company from listing in the U.S. even if the unit selling shares is incorporated outside China. The move could be a huge blow for Chinese companies which have clamoured to list in New York in recent years. There could be fewer and slower new listings in the U.S. due to the government crackdown.

Investors might have to reconsider before placing their bets on Chinese tech start-ups as certain new regulations have been imposed on mainland companies looking to go public in the US. Most analysts were of the view that Chinese companies looking to raise capital might face greater uncertainty about their path to getting listed on public markets which could result in lower valuations. Apart from these technical complexities, the new regulations could mean that similar IPOs in the future will likely need to go to Hong Kong. Faced with the potential of lower returns — or the inability to exit investments within a predictable timeframe — many investors in China are holding off on new bets. Chinese IPOs in the U.S. were headed for a record year in 2021 until Chinese ride-hailing company Didi’s listing in late June on the New York Stock Exchange drew Beijing’s attention. Within days, China’s cybersecurity regulator ordered Didi to suspend new user registrations and remove its app from app stores.

The move revealed the enormity of Chinese companies’ compliance risk within the country and marked the beginning of an overhaul of the overseas IPO process.

What does it mean for IPOs in China?

The path to an IPO in the Chinese market looks uncertain. For Chinese companies applying to the US, they must expect stricter regulations from both sides and a higher degree of scrutiny in the market. Moreover, it could also lead to a potential downfall in the company’s valuation and dampen investor sentiment, thereby making it more difficult for such companies to raise funds in the US. According to the Hong Kong Exchange website, more than 140 companies have filings for Hong Kong IPOs. This just makes us conclude that the Hong Kong market might be an alternative for Chinese companies to go public and might best suit the sentiment of investors. Even though the markets have been brought under control, it might not be the perfect platform for companies to go public at this time in the economy.

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This article has been co-authored by Ishaan Poddar, who is in the Research and Insights team of Torre Capital.

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Crypto Scare: Is the Hype Settling Down?

by Sandeep Kumar

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Crypto Volatility Index (CVI) hit a near one-year high of 127.03 on May 12th. The value of Coinbase, a big bitcoin exchange, has plummeted. A cryptocurrency that advertised itself as a reliable medium of exchange has gone bankrupt. A drop in cryptocurrency values has wiped away more than $300 Bn. The decline in cryptocurrencies is part of a broader shift away from riskier assets, which has been fueled by rising interest rates, inflation, and economic uncertainty resulting from Russia’s invasion of Ukraine. These reasons have exacerbated a “pandemic hangover” that began when life in the United States began to return to normal, damaging the stock values of companies like Zoom and Netflix, which profited during the lockdowns. However, crypto’s collapse is more severe than the stock market’s overall decline. While the S&P 500 has lost 18% this year, the price of Bitcoin has plunged 40% in the same time. Bitcoin has dropped 20% in the last five days alone, compared to a 5% drop in the S&P 500. Let us have a look at the kind of impact the crypto slump is creating on various stakeholders.

How the fall of TerraUSD and Luna has created panic?

The crypto shock occurred primarily after the sudden crash of the stable coin TerraUSD and Luna token. For the past six months, investors bought UST in order to profit from Anchor, a borrowing and lending platform which offered a 20% yield to anyone who bought UST and lent it to the protocol. The idea was criticized as it was likened to a Ponzi scheme which would not be successful. Karma hit the founder, Do Kwon, hard enough who is known for calling out critics as “poor”. Former Terra employees and retail investors in the crypto are holding the Kwon responsible for the losses. While he is still optimistic about his plans to revive Terra, Kwon is facing some major backlash in the form of lawsuits, fines and penalties.

Since May 10th, when TerraUSD and Luna began to show indications of difficulty, cryptocurrencies used by South Korean gaming firms for in-game purchases and trading have experienced erratic trading. As of then, C2X, which formerly used TerraUSD as its main platform thanks to a collaboration with Terraform Labs, the firm behind TerraUSD, which is now depegged from the US dollar, was trading at roughly 1,000 won. According to industry officials, game firms with products that include virtual coins and other blockchain functionality are still on high alert due to the recent collapse of the TerraUSD and Luna cryptocurrencies.

Wemix, a cryptocurrency run by Wemade Co., the maker of the play-to-earn game “MIR4 Global,” dropped by 28 percent during the TerraUSD fiasco before recovering back to the 2,700 won level on May 16th. MBX, Netmarble Corp’s virtual currency, has also plummeted by more than 80% to roughly 11,000 won, compared to around 64,000 won on May 6. Klaytn, a blockchain platform established by internet behemoth Kakao Corp., was also down to roughly 500 won, down from over 650 won on May 10th. Companies are keeping a close eye on the newest developments and concerns in the Bitcoin market in general since a loss of user and investor confidence might jeopardize the gaming industry’s Blockchain ecosystem, which many companies have already extensively invested in. Several crypto exchanges including Coinbase, Binance, Coinswitch Kuber, CoinDCX, even temporarily delisted Luna coin.

Sector euphoria that fueled the NFT boom has given way to more pessimistic conditions, forcing the mostly speculative NFT market to face reality. NonFungible, an NFT data business, stated that transaction volume was down 47 percent in Q1 2022 compared to the previous quarter. The figures are even more dramatic when looking at daily average sales, which fell by 92 percent between September 2021 and April 2022. Such challenges are far from insurmountable. For an NFT market that has been weak on value proposition but strong on hype, a washout was always going to happen. This data will be seen by critics of NFTs as the beginning of the end for projects that have been marked by over-promises, rug pull scams, and flash over substance. A reduction in speculation is more likely to refocus entrepreneurs on adding clear value to digital assets. A more clearly defined use case with a highly motivated and well-capitalized stakeholder to assist drive forward development is required to propel innovation forward.

What to expect in the longer run?

The fall of USDT has reflected poorly over the entire stable coin industry. Developers created functional and safe algorithmic in order to make it less susceptible to government oversight and more resistant to inflation than fiat-backed stable coins. However, they have lost their peg and failed. Some crypto analyst even suggest that the idea of algorithmic stable coins will now be put to rest. On the other hand, despite the volatility in the crypto industry since the beginning of 2022, private equity and venture capital investment into the crypto and Web3 space have been optimistic. The recent shocker has led Terra’s major investors to decide whether to help bail the project out or pull back and escape. While Lightspeed Venture Partners, one of the investors of Luna token, is planning to double down specifically in infrastructure, DeFi and emerging use cases, there is a possibility that the DeFi hype may now calm down. Until economic growth and corporate earnings forecasts are altered, there will be a sluggish flow of fresh money into equities, commodities, bonds or cryptocurrency markets in the coming months.

The arising concerns due to the crashing crypto market have been drawing attention to the regulation of cryptocurrencies. From USA to India, public officials are calling out the need for a regulatory framework to guard against the volatility risks of crypto. The US Treasury Secretary Janet Yellen has called for stable coin regulations to mitigate the risks, ensuring there are no gaps in the regulation. In India, experts are in a process to lay out tax policies for cryptocurrencies. However, naysayers believe that it could disturb the huge potential that the crypto industry brings in terms of intersection of blockchain, machine learning and job creation. Lack of clarity on policies is discouraging innovation in the sector and forcing job seekers to look for opportunities outside India where there are more crypto friendly policies.

A wake-up call for investors

There is no doubt that crypto is a volatile space. The crypto market has survived all this due to the underlying premise that the blockchain is a powerful tool that can change the way the next generation of digital products is built. However, some investors try to make quick money out of these volatile markets. Several people lost their entire life savings through crypto investments. It is advised that investors should research the projects, the technology and promoters before investing in tokens and not just follow returns blindly. Shocks like the recent one will act as a wake-up call and likely make investors mature. As per Sidharth Sogani, founder and CEO of Crebaco Global, a rating, research and intelligence firm focused on blockchain and crypto, more trouble is yet to come. He mentions that as for the crypto market is concerned, we might see a further down or a sideways movement for the next three to six months before it enters the bull market again.

So next time you make any investment decision, especially in a volatile market like crypto, be sure to be patient and do extensive research instead of running after quick returns.

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This article has been co-authored by Sayan Mitra and Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

Flourishing ESOPs in Indian Startups: How can employees make the best of this opportunity

by Sandeep Kumar

Growing Potential of Employee Stock Options in Indian Startup Landscape

This year has proved to be a great year for Indian startups and their employees. With growing valuations and better performance, a large number of companies are opting for ESOPs which has now formed an integral part of the startup compensation system. As a result, many employees were able to earn a fortune overnight.

Employee Stock Ownership Plan (ESOP) is an employee benefit plan that offers employees an option to gain an ownership interest in the company in the form of company shares that are offered to the employees at a pre-determined discounted price. ESOPs convert employees to owners by giving them an opportunity to participate in the future growth of the company by owning a part of it, but also are a great tool to motivate and retain talent.

According to KPMG’s ESOP Survey Report (2021), about 68% of the total respondents have either already implemented an ESOP plan or a similar employee benefits program or are contemplating having one. Of these companies, 72% are private companies. In India, the majority of companies offering the ESOP option to their employees belong to the software and startup sectors. As tech companies have started to realise the growth potential and benefits of the ESOP market, other industries such as Financial Services, Consumer Goods, Automobile sector, etc. have also started adopting ESOP programs for their employees.

Source: KPMG India’s ESOP Survey Report (2021)

Indian Startups on ESOP rush

Investing early on in ESOP options of start-ups can offer great returns to the employees. As of November estimates, ten leading start-ups that have been now either listed or preparing to list soon, have generated over $5 Bn returns for their employees through ESOPs.

Indian startup employees have created a fortune through their ESOP plans as the company’s valuation surged. Freshworks, an Indian SaaS startup, turned 500 of its employees into millionaires overnight as it got listed in NASDAQ this year. Almost 76% of the company’s employees own Freshwork’s shares. Looking at the fashion e-commerce brand Nykaa’s successful IPO launch, the top six employees of the company are estimated to have unlocked way more than the expected $115 Mn of value through their shareholdings and vested options. Even food delivery app, Zomato which had an ESOP pool of $745 Mn at the time of its IPO has now more than doubled in value to $1.5 Bn.

Following the trail, many Indian tech startups are now expanding their ESOP pool to retain the interests of their workers.

Recently, Meesho announced MeeSOP, an ESOP-for-all programme, that would allow all its permanent employees to have a stake in the company’s shareholding, irrespective of their position or tenure in the company. With this, the company aims to break the traditional hierarchy to make every employee an owner. This will allow all its employees to realise their personal and financial goals along with organisational goals, as employees will be able to cash in on the company’s frequent ESOP liquidation drives. Meesho is a high-growth startup, whose valuation is only expected to grow in the future. Hence, the company’s workers will be able to enjoy high gains in the future, given they exercise their vested options.

According to some sources, it is estimated that 80% of employees of the hotel aggregator platform, OYO have been granted the company’s ESOPs. As of September 2021, OYO has an ESOP pool of about 470 million shares of which 11,739 options are exercised. With its IPO coming up and an estimated post-IPO valuation of $10 Bn, it will create a total wealth of $688 Mn for its employee shareholders. Another IPO-bound company, Snapdeal has also expanded its ESOP pool by 151%, offering a total of 5,000,000 ESOP options.

While these are only some of the examples, many more startups are adopting the method to retain top talent — including PhonePe, Licious, Udaan, ShareChat, OfBusiness, Urban Company, to name a few. It is estimated that from January 2020 — July 2021, Indian startups have added $700 Mn worth of stocks. During H1 of 2021, nine companies expanded the pool to more than $170 Mn and the number is expected to have been doubled in the H2 of 2021. Looking at the fortune created by employees of companies like Freshworks and Nykaa, other startup employees also hold a chance to become Crorepatis. However, some hurdles set back workers from exercising their options.

Source: Entrackr

Problems faced by ESOP holders in exercising their ESOPs

As fascinating as they sound, exercising ESOPs is not a straightforward task. Not many employees are even aware or care about how to exercise or when to exercise ESOPs. Read more about the correct time to exercise ESOPs and tax obligations in other articles published on the same channel. As per our estimates, between 70% — 80% of vested ESOPs in unicorn and soonicorn companies go unexercised every year due to the problems faced by employees. This leads to billions of dollars of lost value for them.

Lack of understanding, delay in approvals, and lack of transparent communication from their companies are some of the reasons which hold back employees from exercising their options. Apart from this, heavy tax obligations are a major problem. While exercising ESOPs can provide massive gains to the employees, a major proportion is lost in paying the taxes. As a result, many ESOP holders across companies do not exercise their options as they do not want to pay the capital gains tax. Financing an ESOP can be a costly affair, even for the financially affluent workers.

ESOP Taxation in India

Let us understand what will be the tax implications on ESOPs for an Indian employee.

One may be liable to pay ESOPs tax on two occasions as an employee.

  • First, when the shares are allotted as a result of exercising vested options (taxed as salary income)
  • Second, when the shares are sold as a result of exercising the vested options (taxed as salary income) (taxed as capital gains).

Now let’s look at how ESOP taxation will work:

The first level of taxation (when the option is exercised):

ESOPs would be taxed as a requirement, with the value given as:

The perquisite value of an ESOP will be included in X’s salary and will be taxable in the year in which the shares are allotted. On such an amount, the employer is required to deduct TDS.

The second level of taxation (when ESOPs are sold):

When Mr. X sells the stock, he will be subject to capital gain tax, which will be calculated as follows:

Because X has held the shares for less than a year (counting from the date of allotment), the gains will be categorized as short-term capital gains and will be taxed at the standard slab rates applicable to X.

How Can ESOP Holders Grab the Opportunity?

Due to lack of clarity and huge costs involved, we have seen more than 2,000 shareholders in the past 12 months who are paper rich and cash poor and have made several wrong decisions when it comes to their private shares’ ownership. We aim to make employees aware of these opportunities and help them grab the vested opportunities. As a result, Torre Capital helps ESOP holders with funds required to exercise the stock options and pay tax obligations, with no recurring monthly interest payments, unlike a traditional loan. It is advisable to exercise stock options early so that one can reduce their tax burden and also exercise price in certain cases.

In case of a company’s liquidation event, if the firm has a successful exit (such as an IPO), you repay the principal along with a certain percentage of upside (ranging between 30% to 70%, depending upon the stage of the growth startup) back to your investors. On the flip side, we bear all risks related to performance issues with the investee company, delays in IPO/other liquidation events, or closure/bankruptcy scenarios. Your other personal assets are never at risk because it is non-recourse finance.

So, if you are an employee looking forward to exercising your ESOP options, Torre Capital can provide you with the best and the most convenient exercise and financing journey. Reach out to us at [email protected] in case you wish to know more and seek further assistance.

. . .

This article has been co-authored by Tamanna Kapur and Sayan Mitra, who is in the Research and Insights team of Torre Capital.

For exclusive information about additional research and insights by our Analysts, kindly subscribe to Torre Capital’s Blog.

If you are an investor or shareholder and want more advice about the Pre-IPO secondary markets, please feel free to reach out at [email protected] for investment advice, or register for an account at Torre Capital.

Road to Sustainable Investment: How Are Private Market Investors Responding to ESG Needs?

by Sandeep Kumar

What is Driving Private Market Investors into ESG Investments?

The demand for ESG-certified investments looks to be unstoppable. According to Bloomberg Intelligence research, global ESG assets under management (AUM) will surpass US$53 Tn by 2025 and will soon represent 44% of the global AUM. More than a third of all AUM in the world would have an ESG imprint in the coming future at this rate.

Two parallel developments are driving the increased usage of ESG management systems. First, rising social pressure, a shift in expectations from private enterprise, and continuous legislative reforms have raised the desire for businesses to adopt proactive environmental and societal responsibilities. Second, there is a growing realization among financial and business experts that ESG concerns may have a significant influence on corporate value, and that risk management can help organizations and their shareholders protect economic value.

ESG risk factor methods have sparked the interest of investors of all shades, and progress has been made in applying them. Some of the largest fund managers have adopted ESG on their own, realizing the advantages of incorporating risks into their investment processes. Others are reacting to the rising number of LPs asking ESG-related questions as part of their investigative work and may exert pressure on GPs to include sustainability initiatives into their investing procedures on the margin or even as a mandate to invest.

Long-Term Profit is Closely Linked to Sustainable Investment

The goal of a corporate should be to generate profits without a doubt, but it cannot be the only goal for long. Consider a company that prioritizes money over everything else with little regard for safety or environmental repercussions. What happens to a firm if a defective product is issued or an accident occurs because the business is focused on maximizing the stock price without concerns for the planet and the environment? Not only would the stock price plummet and previously avoided expenditures become due, but litigation, penalties, recalls, cleaning costs, and reputational harm would almost certainly follow, all of which might lead to bankruptcy or liquidation. In the past ten years, cyber security attacks have been a CEO’s nightmare. The next couple of decades may add ESG related concerns to that list.

According to the US SIF Foundation’s research on US Sustainable and Impact Investing Trends, US asset management companies and institutional asset owners have started employing sustainable investing techniques and analyzing the ESG problem in managing their portfolios. The sustainable industry has expanded at a CAGR of 14% over the last 25 years. Since 2012, the most significant surge has occurred.

Greenwashing Concerns

When GPs recognize that ESG is affecting LP commitment choices, they may use buzzwords in their due diligence papers to show they have accepted ESG principles, however all that talk may not be translating into implementation. As per the study of InfluenceMap, the world’s largest asset managers are failing to meet the Paris Agreement’s climate targets. More than half of climate-themed funds failed the test, while slightly over 70% of funds claiming to have ESG compliance failed. In comparison to the US and Asia, Europe is the only region that tracks ESG across the asset management business, and the framework it creates is likely to become a global standard.

Greenwashing is a practice that has drawn attention to the need for honesty in advertising in this industry. Not only are many LPs getting better at exposing asset managers’ ESG claims, but regulators are forcing asset managers to represent themselves and their plans correctly and honestly. TotalEnergies SE, Halliburton Co., Chevron Corp., and ExxonMobil Corp. were all included in climate-themed funds that were exposed to the fossil-fuel business. According to InfluenceMap, three funds dubbed “Paris aligned” and managed by UBS and Amundi SA scored -40% to -26%.

At COP26, it was widely acknowledged that considerably more money is needed for climate adaptation — that is, programs that would mitigate the expected effects of climate change throughout the world. The text of the Pact itself reflected this. The cost of implementing the necessary modifications to achieve “net zero” by 2050 is predicted to be between $100 trillion and $150 trillion. According to GFANZ, private money could provide 70% of the $32 trillion in investment required by 2030 to establish a net-zero economy by 2050. Despite their importance in completing the Paris Agreement, climate tech venture capital and ESG funds are still in their infancy. The increase of private investment removes the load on underperforming governments in terms of capital flow. More cooperation between public and private finances is essential to achieve a speedy transition.

Sector-Wise Effect of ESG

Naturally, various sorts of businesses are subjected to different ESG demands, and some of the imperatives are more intense than others. According to IHS Markit’s survey, 40% of respondents believe the energy, mining, and utilities sector would be most affected by ESG concerns in the next two years, followed by industrials and chemicals (17%) and transportation (17%).

          Source: IHS Markit

The selection of these businesses is likely influenced by the global climate change agenda, with increased environmental legislation and policy focused on companies that emit considerable amounts of carbon. “These are energy-intensive companies,” a partner at a UK private equity company explains. “Mining, for example, makes extensive use of natural resources and conventional energy.” “Companies will have to replace their cars with more fuel-efficient ones,” a UK-based asset management executive says on transportation.

COVID-19 Crisis has Aggravated Investor Focus on ESG

The ESG phenomenon is fuelled by a variety of factors, many of which have been exacerbated by the outbreak. Climate change is a major subject, with COVID-19 emphasizing the interconnectedness of the planets and the fragile link between people and nature.

J.P. Morgan polled investors from 50 global institutions, representing a total of $12.9 Tn in AUM on how they expected Covid would impact the future of ESG investing.

As a result of the COVID-19 crisis, action and knowledge of long-term sustainability concerns are expected to rise in the long run, this should be a beneficial driver for ESG. The majority (55 %) of investors polled by J.P. Morgan believe it will be a positive catalyst in the next three years. Only roughly a quarter of investors (27%) feel it will have a negative impact, while 18% believe it would have no effect.

          Source: J.P. Morgan, Tracking the ESG implications of the COVID-19 Crisis.

COVID has uncovered the costs and unfairness of inequality as social transformation accelerates. A wide spectrum of stakeholders is calling for organizations to be better operated and more responsible, especially in light of taxpayer-funded business support during the outbreak.

Are ESG Factors Shifting Investors’ Focus?

Overall, it appears that regulatory and LP forces are bringing the private markets to the brink of mainstream ESG acceptance. Some GPs are beginning to accept that the risk variables identified as part of the ESG framework are worthy components of the investing process, and reporting and monitoring systems are coming together. LPs are shifting their emphasis from public market operations to private market adoption. However, concerns about greenwashing are growing. The root of the issue is how ESG ratings, such as those provided by MSCI and Sustainalytics, are calculated. Most ratings have little to do with true corporate responsibility, contrary to what many investors believe. Instead, they assess how vulnerable a company’s economic value is to ESG Factors.

There is no doubt about the fact that due to the concerns regarding climate change and the need for sustainability, application of ESG in private markets has started to gain momentum. If you are an investor looking forward to access similar opportunities, Torre Capital offers access to top startups across the globe. Our platform provides seamless financing and investment journey. Feel free to reach out to us for understanding the investment process better.

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This article has been co-authored Vivek Kumar who is in the Research and Insights team of Torre Capital.

Understanding ESOP Taxation and How it Impacts You as an ESOP Holder

by Sandeep Kumar

Keep up to date with the latest research

Employee Stock Options are a component of nearly every unicorn’s pay plan. Not only they are beneficial for the companies, but also give employees a chance to gain the firm’s equity at an attractive price. The growing valuations of startups across the world have also led to the growth of the ESOP market. Southeast Asia emerging as the hub of the startup ecosystem has witnessed a growth in the ESOP opportunities available for the employees. However, on conducting a survey with employees of the top 100 unicorns in Asia, it has been estimated that about 75% — 80% of vested ESOPs remain unexercised in all large startups. As of today, $30 Bn+ of ESOPs remain unexercised in Asia (excluding China and Japan) in unicorn companies. The major reason behind this is lack of understanding among employees, lack of funding needed to pay the exercise price, high tax obligations, and inability to risk personal capital. Most employees are not even aware of how taxes impact the overall ESOP exercise cost and let their options remain unexercised for long periods of time, letting tax obligations rise steeply. We have seen situations with early-stage employees where the tax obligation was 3–4X exercise price because of a sharp rise in startup valuations.

Source: Pitchbook, CB Insights, Primary interviews

As ESOPs grow increasingly common, it’s critical for startup employees to understand all aspects of owning and exercising this key component of their compensation. Done well, ESOPs can be a significant wealth generator for startup employees. In this article, we cover the taxation aspects related to Employee stock options, exercise, and advice on how to manage your tax obligations. We also give you a perspective on how Torre Capital’s ESOP financing program helps your startup make ESOP funding and exercise a painless process and reduces your tax obligations manifold. We have covered a few countries in this article as ESOP taxation is different in every country.

Understanding ESOP taxation in India

A large number of startups in India opting for the ESOP route are on the rise. Several companies including PhonePe, Licious, Wakefit, etc. have rolled out fresh ESOP plans for their employees. A survey by KPMG estimates that over 72% of the private companies in the country have an ESOP plan or are contemplating having one. The growth trend is attributable to easy liquidity opportunities that have created value for ESOPs. But before one exercises the option, it is important to be aware of the tax implications.

In India, you may be liable to pay ESOPs tax on two occasions as an employee.

  • First, when the shares are allotted as a result of exercising vested options (taxed as salary income);
  • Second, when the shares are sold as a result of exercising the vested options (taxed as salary income) (taxed as capital gains).

As a condition of allocation, the difference between the Fair Market Value of the shares (as of the exercise date) and the exercise price is taxed (considered part of salary income). TDS is deducted from the value of the perk as calculated by the employer. This has a negative impact on your cash flow because a greater tax rate is withdrawn from your paycheck without any additional inflow. It is important to highlight that tax is only imposed on the allotment of shares, not on the allotment of options (known as a grant of options in common parlance). When an employee chooses to exercise his or her vested options, shares are allocated, and taxation begins.

As an example, as part of the company’s stock option plan, Mr. X is given 10,000 shares by company A (employer). Mr. X’s taxable prerequisite would be (200–10)*10,000 = 19,00,000 if the Fair Market Value of the shares on the day of exercise is 200 per share and the exercise price is 10.

Assuming Mr. X is in the highest tax rate with a 10% surcharge, the tax on $19,000 would be deducted at 34.32 percent (with a 4% cess). An additional TDS deduction of 6,52,080 is resulting as a result of this.

The employee must either sell a few shares or make other arrangements to fulfill this obligation due at vesting.

Moving on to the second type of taxes, capital gains tax is imposed on sales, which can be long or short term depending on the holding period. If you’re asking what the cost of acquisition is for capital gains purposes, the answer is the Fair Market Value on the exercise date (used to calculate the perquisite value).

Changes in Budget 2020

Startups (who rely heavily on ESOPs to retain people) ran into practical challenges when it came to taxing ESOPs as perquisites. As previously stated, an employee must either sell a portion of his stock or arrange for funds from other sources to pay his TDS liability. Finding buyers for startup shares can be difficult because they are typically not listed and may not have an active market. The Income Tax Act was revised to grant relief to ‘qualifying startups’ after examining numerous representations and acknowledging the true hardship encountered by entrepreneurs.

What are eligible startups?

In simple words, an eligible startup is a corporation or limited liability partnership formed after April 1, 2016, but before April 1, 2022. In addition, it must meet the turnover requirement (no more than 100 crores) and engage in suitable business as defined.

What is the relief provided?

An eligible startup can deduct TDS within 14 days:

  • After expiry of 48 months from the end of the relevant assessment year or
  • From the date of sale of such shares or
  • From the date, the employee resigns.

So, if you receive shares in FY 2020–21, the earliest date on which your employer (as an eligible startup) is required to deduct TDS is April 14, 2026 (assuming you continue to hold the shares and are in employment with the company till that date).

It’s a smart decision because the employee now has at least 5 years to pay tax on the perquisite income unless he resigns or sells the stock before then. It allows the employee to keep his or her shares rather than being obliged to sell a portion of them to fulfill tax requirements. What’s not fair is that the relief is only available to employees of startups who qualify. The number of qualifying start-ups in relation to the overall number of ESOPs issued is insignificant. As a result, the majority of startup employees will be unable to make use of this choice.

Perquisite Tax and Capital Losses

Taxing ESOPs in the year of allotment might result in another potential loss from a tax perspective if the value of the share drops significantly after paying tax on fair value.

In the example discussed above, if Mr. X decides to hold on to the shares by paying tax of ₹ 6,52,080 (assuming Company A is not an eligible start-up) from his personal savings and within a few years’ time the value of the share drops to say ₹ 20 (possible sometimes) he will have a capital loss of ₹ 18,00,000 (10,000*(200–20)).

Salary income cannot be used to cover capital losses. If Mr. X does not have enough capital gains to offset the loss, he may be forced to carry the loss forward for the allowed term and then write it off. Allowing capital losses to be offset against salary income, to the extent that these losses are related to ESOPs, is a big help.

Salary income cannot be used to cover capital losses. If Mr. X does not have enough capital gains to offset the loss, he may be forced to carry the loss forward for the allowed term and then write it off. Allowing capital losses to be offset against salary income, to the extent that these losses are related to ESOPs, is a big help.

EXAMPLE: Mr. X, an employee of ABC Pvt Ltd, was given an ESOP option to purchase 10,000 shares of ABC Ltd on July 1, 2014. According to the policy, the option can be exercised at the end of three years, on July 1, 2017, for INR 60.

Mr. X chose to execute his option on July 1, 2017. At the time, the fair market value of ABC Ltd’s shares was INR 100. He also decides to sell the shares at a price of 120 per share on January 31, 2018.

Now let’s look at how ESOP taxation will work:

The first level of taxation (when the option is exercised):

ESOPs would be taxed as a requirement, with the value equal to (FMV per share — Exercise price per share) × number of shares allotted (on the date of allotment).

The sum computed above as the perquisite value of an ESOP, i.e. Rs. 4,00,000, will be included in X’s salary and will be taxable in the year in which the shares are allotted. On such an amount, the employer is required to deduct TDS.

The second level of taxation (when ESOPs are sold):

When Mr. X sells the stock on January 1, 2018, he will be subject to capital gain tax, which will be calculated as follows:

Because X has held the shares for less than a year (counting from the date of allotment), the gains will be categorized as short-term capital gains and will be taxed at the standard slab rates applicable to X.

For listed shares, a holding period of over a year is considered long term. While for unlisted shares, holding period of over 2 years is considered long term.

Currently, the long-term capital gains on listed equity shares (on a recognized stock exchange) are tax free up to Rs 1,00,000, however, short-term capital gains are taxed at 15%. However, in accordance with section 112A of Finance Act 2018, any amount more than Rs 100,000 is taxed tax at 10% without indexation (plus health and education cess and surcharge). This is subject to some criteria, including the condition that transfer has taken place on or after 1st April 2018. Short term capital gains shall be taxed at a flat rate of 15% as per Section 111A.

If the shares are not sold through the stock exchange’s platform, long-term capital gains are calculated by indexing the original purchase price. Indexed gains will be taxed at a 20% flat rate, plus any applicable surcharges and cess. Short-term capital gains are treated like any other form of income, and combined with other kinds of income, being taxed at the appropriate slab rate.

ESOPs Issued by Foreign Companies

Employees of Indian enterprises are frequently given ESOPs from the parent company, which is based in another country. The tax treatment of the allotment remains unchanged. It is still subject to taxation as a condition of employment, and the employer (an Indian corporation) is required to deduct TDS. It increases the compliance cost because these shares must be declared as foreign assets in the ITR, and you can’t submit ITR 1.

The question of whether capital gains are taxable in India or the foreign country where you hold these shares arises when you sell these shares. The answer is that it depends on your residency status; a resident pays tax on all of his income, regardless of where he lives. As a result, if you are a resident, you may have to pay taxes in both nations. However, you can qualify for relief under the Double Taxation Avoidance Agreement (if India has such an agreement with a foreign country). This must be determined on a case-by-case basis.

To summarise, ESOPs play an important role in the remuneration structure of employees. The benefit of tax deferment should not be limited to only “qualified startups.” Even if the relief provided to “qualified startups” is not as appealing, a scaled-down version of the same may be required.

Inter Country ESOPs

ESOPs are often provided by the parent business to the group’s employees. However, tax issues arise when a delegated employee moves from a parent company in one nation to a subsidiary in another. Typically, the nation of service at the time of ESOP issuance may differ from the country where vesting and exercise occurs, resulting in a taxation rights apportionment issue between the countries.

How are ESOPs Taxed in this Case?

The first stage is to determine an employee’s residential status for a given year. In the event that an employee becomes a resident of more than one nation in a given year, the ultimate residential status must be determined using a tie-breaker test in accordance with the tax treaty. ESOP benefits are taxable in a country based on the number of days the employee worked there.

Example of how ESOPs are taxed between two countries:

On 1st May 2013, A Ltd (Indian Parent) issues 150 ESOP options to the employee for Rs.100, with the proviso that the options vest over three years, i.e. 1st May 2014, 1st May 2015, 1st May 2016 (per year 50 options), as long as the employee is employed by any business in the group.

On January 1, 2015, an employee is assigned to a foreign subsidiary. The taxability of ESOP perquisites for the second vesting, which occurred on May 1, 2015 (assume the date of exercise: 1st May 2015). On May 1, 2015, the FMV of the shares was Rs.1100. The perquisite is Rs.1000 (i.e. FMV Rs.1100 minus Option price Rs.100).

Tax in India will be calculated from the date of grant (1 May 13) to the date of departure (1 January ‘15), a period of 610 days, and tax in a foreign country will be calculated from the date of arrival (1 January ‘15) to the date of vesting/exercise, a period of 120 days.

Key Points Covered in Inter-Country ESOPs Transactions

a. Divergence in tax treatment

Perquisites are apportioned based on the number of days of service provided in respective nations throughout the grant and vesting periods for ESOPs issued in country A and exercised in country B. However, if enough time has passed between the date of departure from country A and the date of exercise in country B, country B does not tax its portion on the basis that the ESOP was not granted in anticipation of duties in country B.

b. Double Taxation

When an employee of an Indian parent exercises shares while in India, the difference between Fair Market value and option price is subject to perquisites tax in India. After then, the employee is sent to a subsidiary abroad, where he or she sells the shares while serving in the company. In the year of the sale of the shares, the employee would have become a tax resident in the foreign company and would be responsible to pay tax on all of his or her earnings, including the capital gain on the sale of the shares. The FMV should preferably be used as the cost of shares when computing such capital gains. Due to the fact that perquisite tax is remitted in India, foreign jurisdictions usually treat option prices paid as a cost rather than FMV. The FMV must persuade foreign tax authorities that it is a fair cost for calculating capital gain. Employees would otherwise be taxed twice on the portion of the difference between the FMV and the option price they paid.

c. Cash Flow

Employees from the parent firm are occasionally delegated to the foreign subsidiary. Following the assignment of shares, the employee is required to pay perquisite tax in India and overseas, based on the number of days of work given in each country. However, culpability arises in this instance when the employee is abroad. He will have a difficult time remitting his Indian tax liability in INR to the parent firm because he will no longer be paid in INR and will have closed his Indian bank account.

You need to become aware of ESOP taxation and its implications on your future wealth. ESOPs have a lot of laws and requirements to follow. Companies that provide it to their employees must have an appropriate administration system in place to ensure that they have stock ownership. If a corporation lacks the personnel or resources to oversee the administration of ESOPs, it may expose itself to certain risks. The corporation must have proper administration, staff, including third-party administration, legal costs, and trustees when establishing ESOPs. It needs to be aware of the costs associated with providing this service.

ESOP Taxation in Singapore

Singapore is the startup hub for Asia. In such a thriving ecosystem, ESOPs have emerged as an ideal tool for private companies. When it comes to determining the tax on ESOPs, there are a number of variables to consider. In Singapore, ESOP taxes are only levied once — at the time of exercise or when the ESOP’s selling restriction is repealed. Any gains or profits resulting from the execution of a share option will be taxed to the employee who received them from their employer. When options are exercised, tax is payable on earnings emerging from an ESOP with no selling restriction. Furthermore, ESOPs with selling restrictions are only taxed in the year the restriction is eliminated.

If the stock option’s open market value exceeds the exercise price, the difference is considered a profit for the employee. This profit is taxable since it exceeds the employee’s basic salary.

Note — The intrinsic worth of an asset is known as open market value. It is largely reliant on supply and demand market variables. This value changes over time and is quite dynamic.

In terms of a mathematical formula,

The taxable amount is then subjected to the applicable tax rate for the employee

Singapore personal tax rates start at 0% and are capped at 22% (above S$320,000) for residents and a flat rate of 15% to 22% for non-residents.

Example:

At a $1 exercise price, Lee holds 1000 stock options in a firm called ‘Herbilitie.’ Lee now has two choices. If the open market value of each share is $5 at the time of exercise, and the tax rate on Lee’s stock options is 20%, then:

ESOP Taxation for Foreign Employees

If an employee is given ESOPs while working abroad, the profits are not considered income in Singapore and are therefore not taxable there. In such circumstances, the ESOP tax computation is based on the double taxation avoidance agreement between Singapore and the nation where the employee was given ESOPs. However, if ESOPs are granted to the employee in Singapore, two rules are applicable:

a. Deemed Exercise Rule: The presumed exercise rule applies to ESOPs given to foreign citizens working in Singapore on or after January 1, 2003. Employees may have ESOPs that have not been used when their employment ends. The final profits from unexercised ESOPs are considered income obtained by the employee one month before the date of termination of work or the date on which the monetary benefit is granted, whichever comes first. When a foreign employee’s employment ends, they are regarded to have received a final gain if they have one of the following:

  • Unexercised ESOPs;
  • Restricted ESOPs where the moratorium has not been lifted

b. Tracking Option Rule: The tracking options rule, which is an alternative to the deemed exercise rule, permits the employer to trace the period when the foreign employee realizes ESOP gains. The gain is subsequently reported to the government by the employer. The following events are monitored:

  • Exercise of unexercised ESOPs
  • Restricted ESOPs where the moratorium is lifted

Note:

 If the employer has been permitted to use the tracking option rule, the considered exercise rule does not apply.

• When an employee leaves Singapore for more than three months, regardless of the reason, ESOPs are taxed.

Employee Remuneration Incentive Scheme (ERIS) for startups

The Equity Remuneration Incentive Scheme, or ERIS, only applies to stock options given between February 16, 2008, and February 15, 2013, inclusive (both dates inclusive), as long as the award date is within the first three years of the company’s establishment.

Employees who profit from their employers’ ESOP schemes are eligible for ERIS tax benefits. Employees who participate in ERIS might get a tax break of up to 75% on their ESOP plan gains. Tax can be waived for a period of ten years provided certain criteria are met. The tax exemption is restricted to $10 million in accumulated gains over a ten-year period, and the gains must be realized on or before December 31, 2023.

ESOP Tax Deferment Option

Employees can choose to defer the payment of tax (subject to an interest charge) on the gains from ESOP for any period of time up to a maximum of 5 years. Conditions for ESOP tax deferment:

  • For ESOPs with a staggered vesting period, only the proportion of shares that have not vested
  • At the time the ESOP is granted, the employee must still be working in Singapore
  • The employee (who receives the share option) must be someone who:

a. is not bankrupt

b. does not have a poor tax-paying record

c. possesses a tax of more than $200 on ESOP gains

d. has not been granted area representative status, and

e. is eligible to settle tax by installments under current tax rules

Understanding ESOPs in Indonesia

The ESOP market in Indonesia is still gaining popularity. Founders are educating themselves to provide the best ESOP options to retain their talented employees.

In Indonesia, employee stock option schemes are not subject to any specific regulations. Offering stock in a firm is considered a personal matter. As a result, a business can impose any standards it sees fit.

Normally, income tax is required only when a profit is realized after the shares are sold. According to Regulation of the Directorate General of the Tax Office No. PER-16/PJ/2016 dated 29 September 2016 (PER-16), income tax is owed on revenue derived from a party’s work, services, and activities in or outside Indonesia, including:

· Salary.

· Wage.

· Remuneration.

· Allowance.

· Other payments in any form related to a person’s work or office, services, or activities.

A dividend or a capital gain might be received by a shareholder via the selling of shares obtained under a share option scheme. Profits from the selling of stock are considered capital gains and are taxed accordingly. Income tax is determined at the following progressive rates based on the taxpayer’s annual income:

· Up to IDR50 million: 5%.

· From IDR50 million to IDR250 million: 15%.

· From IDR250 million to IDR500 million: 25%.

· Above IDR500 million: 30%.

The rates listed above are for taxpayers who have a Tax Identification Number (NPWP). Those who do not have an NPWP may face higher fees.

Any dividend paid, available to be paid to, or payment due from a government institution, national taxpayer, event organizer, permanent establishment, or representative of a foreign company to a national taxpayer or permanent establishment is subject to 15 percent tax under Article 23 of Law №7 of 1983, as amended by Law №36 of 2008 on Income Tax (Income Tax Law).

Share system tax effects must be examined on a case-by-case basis, based on the exact scheme used by the company. As a result, the corporation must engage with its tax consultant about its intended scheme.

Understand, Exercise, Benefit

Many employees choose not to exercise options because they find the taxation and the entire process to be overwhelming. As a result of lack of understanding, huge costs, and lack of easy liquidity options, employees miss out on great investment opportunities. It is estimated that those who had successfully exercised their ESOP were able to more than double up their investment returns as the company became public. Torre Capital is committed to providing you complete guidance and the best platform throughout your ESOP journey. Our non-recourse financing options minimise the risks for employees. We aim to maximise employee returns by minimising the costs involved.

So, if you are an employee looking forward to exercise your ESOP options, Torre Capital can provide you with the best and the most convenient exercise and financing journey. You can reach out to us at [email protected] in case you wish to know more and seek further assistance.

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This article has been co-authored by Sayan Mitra and Tamanna Kapur, who is in the Research and Insights team of Torre Capital.

Why are High-Growth Companies Staying Private for Longer?

by Sandeep Kumar

 

 Pre-IPO And Secondary Market Trading

In the recent times, the pre-IPO market has emerged as an attractive alternative class for investors as they allow them to reap out the maximum benefits before the company goes public. While the pre-IPO market is considered to be a good opportunity for providing early access to huge potential gains, it may have some liquidity constraint. However, the pre-IPO secondary market allows the founders, early employees, and investors to receive liquidity much sooner in a company’s life cycle. The secondary market balances the need for liquidity and allows founders to stay motivated and focussed on building the company, while staying private for longer durations.

Secondaries trading platform like Torre Capital are committed to democratizing the Pre-IPO market, by making it secure and accessible to all. With a large number of companies achieving the unicorn status and having a great IPO exit, the pre-IPO space is booming more than ever. We shall look upon the various factors that have motivated the companies to stay private for longer and delayed their exit.

Pre-IPO Secondaries Volume Growth

Secondary market trading are stock transactions in which an existing stockholder sells their stock for cash to third parties or back to the company itself before the company undergoes a merger, acquisition, or initial public offering. While the secondaries market was impacted in the early 2020, due to the pandemic, it has rebounded and witnessed continued growth since then. With over $50 Bn secondary deals completed in the first half of 2021, the transaction is projected to reach $100 Bn by the end of the year. It is estimated that over the next five years, the annual secondary volume could reach $250 Bn as limited partners manage their portfolios more actively.

Growth of Secondaries (in $Bn)

The high amounts of funding rounds in the recent time period, along with optimistic valuations in the future, will continue to give a positive indication about the growth in secondaries activity.

Why are more companies opting to remain private?

Companies that go public gain an instant infusion of money by selling all or part of their firm in a public offering. While this may appeal to certain businesses, others recognise that public ownership has a cost. They avoid having to report to a big group of shareholders and can keep their company strategies and finances confidential by opting to remain private.

Source: McKinsey&Co

It can be seen that from the late 1990s to 2016, the number of publicly traded firms decreased by 52%. Despite this steep decrease, the entrepreneurial spirit has never been greater everywhere on the planet. The United States is ranked first in the world in the Global Entrepreneurship Index.

People are eager to establish their businesses. They just don’t want to share them with the rest of the world. The additional restrictions needed of publicly listed firms are one of the reasons companies don’t want to cope with the inconveniences of becoming public. The Securities and Exchange Commission is enacting increasingly harsh restrictions, which most firms would want to avoid.

This is especially true in situations when a large number of employees are also stockholders. Employees are free to focus on their tasks rather than the statistics since they don’t have to worry about what the stock is doing and what that could entail for their money.

Another reason a business could prefer to remain private is to have more control over its operations. A firm can remain in the hands of a few select people or families by remaining private. In addition, private firms are not subject to the whims of stockholders.

Private equity firms alone spent $130.9 Bn in biotech and tech start-ups in 2018. IPOs, on the other hand, took in $50.3 Bn. It should come as no surprise that, with so much money at risk and considerably fewer headaches, more private firms are opting for private equity.

There are several motivating factors for a company to go public. However, such access comes at a hefty cost in the form of SEC and shareholder scrutiny. As a result, many private firms opt to remain private and seek funding from other sources. Traditional lending institutions offer secured loans and shares that may be used as personal money or sold to employees to raise funds. This implies that while investing in private firms is feasible, it generally necessitates intimate links to the company.

How Has The Decision Benefited Tech Companies

The decision about whether to go public or stay private varies from company to company. Having a successful IPO may be important for a company, however it comes with several hassles, in terms of regulation level and the time involved. The dynamic of software firms within the IPO space is such that they do not wish to take the hassle and risk involved in secondary market trading or pre-IPO placements. With IPOs definitely a lot of risk is involved in not being able to match up to the investment that has been made and generating enough profits. Going public does help raise capital but it is an expensive endeavour for the company itself.

Software firms are approaching private equity firms instead for capital as that opportunity comes with less risk involved and fewer drawbacks. This is due to the sheer amount of capital in private equity that gives a strong standing to the firm. Technology corporations have raised successful funds in the private rounds that have made them achieve the decacorn status while staying private. On the other hand, entering into a public market through IPO may also possess the risk of downside. Astudy by Battery Ventures estimated that over 40% of the unicorns that have gone public since 2011 have underperformed their final private-market valuations. From company’s average age of 4 years to go public, in 1999, to the 2014 average age of 11 years, we see a change in preference of the companies in the decision to stay private.

Late Stage Investors Enjoy Higher Returns

As mentioned before the growing scale of fundraise rounds lead to inflated valuation of startups. While high valuation may be good for the company, overvaluation may pose a risk of downside. As a result investors, especially late stage investors avoid counting on IPOs to make money. On the contrary, early stage investors remain unaffected with the downside risk as they invest early enough to gain positive returns.

As early employees and investors seek liquidity, the private market activity steps up in such a scenario. A delayed IPO would give the late stage investors more time to reap the benefits of the growing valuation and greater returns.

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This article has been co-authored Tamanna Kapur and Vivek Kumar who is in the Research and Insights team of Torre Capital.

 

Upcoming Indian Unicorns: Fintech Companies that are racing to join the Unicorn Club

by Sandeep Kumar

Keep up to date with the latest research

 

The Emerging Landscape of Indian Soonicorns

 

Indian startups are booming and the country has emerged as the third largest startup ecosystem in the world. In 2021, India added three unicorns to the club each month. With a total of over 66 unicorns currently, the number is only growing. While Paytm, Byju’s, Cred, etc. are some of the common names; startups like OfBusiness, Apna, Zetwerk, etc. which were almost unknown over the last couple of years among the general masses have now entered the Unicorn Club. We aim to bring out such names that have not yet achieved the $1 Bn mark but have a huge potential to make profitable deals in the coming future.

 

The Growing Market for Indian Fintechs

 

Currently valued at $31 Bn, the Indian fintech industry is projected to grow at a CAGR of 22% from 2021 to 2025. Despite the pandemic, India’s fintech market has witnessed a growth in investments, raising over $2 Bn in the first half of 2021. Digitisation of financial services in the recent years, along with diversification of the sub-sectors has led to the growth of the market. Paytm, one of the most successful unicorns in the sector, is expected to go public with a valuation as high as $ 25–30 Bn.

 

Looking at the current valuation and fundraise of the companies, along with their market traction, we bring out to you some of the most promising soonicorns in the fintech industry. Early investments in such startups will help investors gain more profits.

 

1. CredAvenue

 

 

Rationale: Founded in 2017, CredAvenue offers comprehensive debt products for enterprises and connects them with lenders and investors. With transactions worth $9 Bn and over 1,500 institutional borrowers and over 750 lenders on its platform as of 2020, the company is set to grow and expects its revenues to reach $67 Mn by FY22. Given the growing need for credit among Indian SMEs and the widening credit gap, CredAvenue has the potential to be among the top performing firms in the credit market.

 

2. ZestMoney

 

 

Rationale: ZestMoney is a fintech platform that allows its users to avail digital EMI and BNPL services, without the need of a credit card or a credit score. The firm enables its users to pay in EMI with the use of digital banking and artificial intelligence. With penetration across 15,000 stores and 6 million users, ZestMoney expects to cross 400,000 stores by 2021. The company expects its revenue to reach $47 Mn by FY22, growing at the rate of more than 120% over the period of two years. The growing trend towards digital payments in India and the need to make it accessible across the Indian population will only boost the growth potential of the company.

 

3. Smallcase

 

 

Rationale: Smallcase offers a wealth management platform to the investors, aimed at democratizing equity investments by providing better investment opportunities in a basket of stocks and ETFs. From a wide range of portfolio options, Smallcase has provided returns as high as 186% to its users. However, these high returns also come along with higher volatility risks. A quarterly managerial fee is charged by the users, which is dependent upon the potential upside of the portfolio. Smallcase has benefitted from Indians’ growing interest towards investments, this is evident from the company’s growing user base — from 1.5 million investors on the platform last year to 3 million in 2021. Given the growing engagement in investment activity, Smallcase is expected to witness high growth in future.

 

4. Rupeek

 

 

Rationale: Rupeek is an asset bank digital lending platform that aims to monetize India’s $2 Tn gold economy. The company is among the fastest growing fintechs in the country, with a tremendous revenue growth rate of 7,295% over the last three years. With interest payments on gold loans starting as low as 0.69%, Rupeek provides a better option than some of the leading loan financing companies making it a preferred alternative among its competitors.

 

5. Khatabook

 

 

Rationale: Khatabook enables micro, small and medium merchants to track business transactions safely and securely. It offers a range of products that provides staff management, expense management, business management and ledger application services to its clients. Despite witnessing a YoY growth of 150% in FY 2020–2021, Khatabook has zero operating revenue. We believe that the company is currently overvalued and this could lead Khatabook to achieve unicorn status very soon.

 

6. Open

 

 

Rationale: Open is a neobanking platform primarily for SMEs and startups that offers business accounts and other services that makes finance management easy for businesses. Open successfully processes $20 Bn transactions annually, and aims to grow from catering close to 2 million SMEs, to 5 million paid subscribers by the end of the year. Still in its nascent stage, the neobank platform is looking forward to expanding its services to cater to the needs of accountants, and possesses great potential to rise in the long run.

 

7. Mswipe Technologies

 

 

Rationale: Mswipe Technologies is a point of sales solutions platform for all types of payments that serves the smallest of merchants. Backed by Ratan Tata Associates promoted fund, Mswipe currently has about 670,000 merchants in its network and hopes to expand it to a million merchants. However, the company’s revenue-to-loss growth gap widened in FY 2020, with operational revenue increasing by 35% and losses increasing by 250%. Apart from the growing demand for PoS solutions in India, Mswipe’s plans to turn into a digital SME bank in the coming 4–5 years, might improve Mswipe’s financials over the years.

 

8. Acko

 

 

Rationale: Acko is an insurtech company that offers automobile and health insurance policy options to its customers. As of Q1 of FY 2022, Acko has experienced a substantial sales growth of 120% for automobile insurance policies, compared to that of FY 2021, with a gross premium of about $11 Mn USD (INR 81 Cr). The company is looking forward to raise $200 Mn in a late stage VC round which could provide Acko a unicorn status with a 2.5x jump in its valuation.

 

In the Flurry to be Unicorns

 

The valuation of Indian fintechs has grown in 2021, and it will continue to grow in the coming years with growing interests in digital payments, e-commerce, investments, etc. Coinswitch Kuber, being the most recent one to enter the unicorn club, saw a valuation growth of 4 times, jumping from $500 Mn to about $2 Bn. With the most awaited Paytm IPO, fintech exits are expected to boom in the next couple of years. Grabbing on these opportunities a little early will provide higher returns to the investors.

 

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This article has been co-authored by Tamanna Kapur , who is in the Research and Insights team of Torre Capital.

 

 

Understanding how the pandemic has fueled the growth of the Secondaries Market

by Sandeep Kumar

Keep up to date with the latest research

 

Secondaries Market and its Performance during Pandemic

The buy-and-sell of pre-existing investor commitments to private equity and other alternative investment funds is referred to as the private-equity secondary market. Transferring interests in private equity and hedge funds can be more complicated and time-consuming due to the lack of established trading venues for these interests. Private equity has traditionally been an illiquid sector, with institutional investors acquiring buyout funds and waiting more than ten years to enjoy the rewards. Private Equity was designed for investors who preferred to buy and hold assets rather than sell them for a quick profit.

Market downturns have historically had a short-term impact on secondary markets. The Covid-19 pandemic has brought about an evolution in the financial world and a similar change has been witnessed in the private equity secondary market. Through this article we will understand how the secondaries performance has fuelled post the onset of pandemic.

Historical Returns in the Midst of Pandemic

Market downturns have historically had a short-term impact on secondary markets, reducing transaction volumes, delaying realisations and distributions, and placing downward pressure on price. Secondary markets have usually returned from market downturns with significant activity, and have presented excellent possibilities for investors with available investment money once volatility has subsided and stability has been restored.

During the pandemic, due to great degree of uncertainties and subsequent volatility, investors in the secondary market grabbed the opportunity by buying the dip and securing their positions by purchasing at greater discounts. According to Greenhill’s Report, greater interest has been seen particularly in COVID-proof” sectors, newer vintage funds and more concentrated exposures, which are easier to diligence and underwrite. The secondary market experienced large volume growth in the second half of 2020 and into 2021. In 2021, we can expect secondary transaction volume to hit new highs. Secondaries may find more enticing pricing as a result of the market’s uncertainty, resulting in increased prospects and profitability.

Why the secondaries market are attractive?

· Recent Vintages (post-2015): Recent vintages with unfunded capital have become more attractive to investors in the present circumstances. Investors get insight into the portfolio and platform investments, as well as assurance that the increased cash available may be used offensively as well as defensively. High-quality GPs with ample money who are seen as capable of handling market disruption are especially appealing.

· GP-led Transactions: The number of tail-end funds and older assets appears to have risen with the possibility that the COVID-19 epidemic would further delay exits. High-quality general partners have continued to use the secondary market to maintain high-performing firms while also providing current limited partners with a liquidity alternative. With a number of secondary deals started this summer, the GP-driven market has led the resurgence in secondary transactions.

· Single Asset Transfers: As the frequency of single asset transactions in high-quality firms increases, general partners keep seeking for methods to keep their best companies. Diversifying among funds is one method secondary investors may reduce concentration risk. Single asset transactions are especially desirable in the COVID-19 environment since it is easier to assess the impact of COVID-19 on a single firm than a large mix of portfolio.

· Dry Powder Advantage: These days, investors are demand more liquidity and the ability to rebalance their portfolios across asset classes. Due to this demand, a secondary market has emerged where investors may sell or buy private equity commitments rather than just waiting for a return. The seller of a PE share can access liquidity in the secondary market, just as in the normal stock market, while the buyer receives access to private equity funds and diversification.

It has been estimated that in the year 2020, players in the secondary market have enjoyed high levels of dry powder that is ready for deployment. They are in a position to enjoy profitability by buying in at above average discounts to lock in greater appreciation. With the current trends, it is estimated that the transaction value for secondaries will exceed $100 Bn by the end of 2021. The growth trend is not expected to end anytime soon as markets are now more liquid than ever due to technological innovations in the field and the growing acceptance of digital assets and tokenization.

Source: Acuity Knowledge Partners

Secondary Buyouts

Since 2006 to 2019, SBOs have witnessed a growth of 5.2% per year. This option has been experiencing rising popularity due to better liquidity options and lower risk staregies. Study conducted by Deloitte estimated that more than half of the investors surveyed expect SBO funds will offer one of the best opportunities for returns over 2020–2021.

Source: Deloitte Insights

The Way Forward

As a result of the current market dislocation, protracted volatility, and ongoing pandemic, the secondary market has seen lower pricing and more opportunities in younger assets. Financial decisions made by investors in the secondary market may be influenced by structural changes caused by economic crises, and failing to account for these fundamental breakdowns in the market may result in investors making incorrect interpretations and portfolio selections. However, secondaries are still, absolutely a great place to put your money. In the second half of 2020 and into 2021, the secondary market saw significant volume growth. Secondary transaction activity is expected to reach new highs in 2021.

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This article has been co-authored by Tamanna Kapur and Sargam Pallod , who is in the Research and Insights team of Torre Capital.

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