Mar 8, 2007

Pushing Startups To The Fringes

In his latest Budget the Indian Finance Minister has proposed Fringe Benefit Tax on stock options that employees exercise starting April 1, 2007. Now it may appear a great way to collect additional taxes (assuming FBT = Marginal Tax of 33%), but the long term impact will be stifling innovation and increasing employee churn in the Indian economy. Startups will find it even more difficult to attract/retain talent with ESOPs as the net gains post exercise are diminished.

Employees with vested options are now forced to exercise them which means no more exit (quit) barriers. Though an option grant typically takes 4-5 years to vest, the total lifecycle is much longer. Vested options take another 5 years to expire which means a manager conserving cashflows will tend to stick around that much longer, almost a decade. Now a decade is a long time, and often committed managers is all that separates a stunted SME to one that really grows wings to become a bluechip. Just look at the number of 'major' IT Services companies in the early nineties, that have now fallen by the wayside.

For now, look for increased attrition at mid and senior levels across industries, rising wage inflation (employers will have to compensate for unattractive esops) and one more setback to the nascent startup-ecosystem in India. Unless the government realises the total impact and pegs FBT at a reasonable 10-12% range.

1 comment:

Melroy said...

Some of the additional potential implications of FBT on ESOP that come to mind are:
a) ESOP's have been known to be one of the best stimulants for entrepreneurship in this country with several beneficiaries leaving their employers (offcourse after putting in a number of years) to become employers themselves. This move could severely inhibit use of ESOP in the Indian industry and hence reduce the number of potential entrepreneurs in India.
b) Greater amount of the ambitious Indian talent could start looking out for overseas postings for wealth generation.
c) Within the Indian job market, most of the India based companies (for whom a great value proposition to their prospective employees has been the promise of future benefits) would be less competitive in the job market than their more established, North America based rivals.
Additionally, in the short term, there is now a mad rush by a number of ESOP beneficiaries to exercise their options before the 1st April deadline. The people who seem to be benefitting most from this are the banks who have taken this opportunity to provide loans at what they call 'attractive rates'.
In short, I hope the FM considers this move from all angles before formulating the details of the final policy on this.