Unlocking Startup Wealth: Satish Mugulavalli on ESOP Liquidity & the Rise of India's Secondary Market
Satish Mugulavalli, Founder and Managing Partner of Hissa Fund, unpacks ESOP liquidity, secondary markets, & startup investing in India. Turn paper wealth into real gains! 🚀
From Flipkart's massive ~$700 million ESOP payout to Swiggy's recent IPO estimated to mint hundreds of crorepatis among its employees, Employee Stock Option Plans (ESOPs) have created significant wealth in the Indian startup ecosystem. But for every headline-grabbing success story, countless employees hold valuable options locked up for years. How does this "paper wealth" turn into tangible cash, especially before a major exit event?
This critical question was explored in a recent episode of the Founder Thesis podcast featuring Satish Mugulavalli. As a tech entrepreneur, former VC, and now Founder and Managing Partner of Hissa – India's first ESOP liquidity fund – Satish brings 25 years of experience to the table. He shared insights on navigating the complexities of ESOPs and the solutions emerging to provide much-needed liquidity, starting with the basics.
Check out the video of the conversation here or read on for insights.
So, what exactly are ESOPs, and why is unlocking their value such a vital topic? Let's dive into ESOP 101.
ESOP 101: Decoding the Employee Wealth Tool 🗝️
Satish explains the fundamentals:
What is it? An option (the right, not the obligation) granted to an employee to buy company shares at a predetermined price (the strike price) at some point in the future. Think of it as a voucher to buy shares later at potentially a very good price.
Vesting: This is the process of earning the right to buy those shares. It's usually tied to how long you stay with the company or achieving specific milestones.
Common Structure: A 4-year vesting schedule with a 1-year "cliff" is standard, borrowed from the US model.
Cliff Explained: You must stay employed for a minimum period (the cliff, mandated as 1 year in India) before any options start vesting. If you leave before the cliff, you typically get nothing.
Post-Cliff Vesting: After the cliff, options usually vest incrementally (e.g., monthly or quarterly) over the remaining vesting period. So, after 1 year in a 4-year plan, 25% of your options might vest, with the rest vesting steadily until year 4. Some companies use "back-loaded" vesting (e.g., 10% year 1, 20% year 2, etc.) to incentivize longer tenures, especially in deep-tech.
Exercise: This is the act of actually buying the shares you've earned the right to purchase. You pay the pre-agreed strike price for each share you want to convert from an option to actual equity.
The Tax Trap ⚠️ (Perquisite Tax): This is critical in India! When you exercise your options, the government views the difference between the share's Fair Market Value (FMV) at that moment and your strike price as a benefit (perquisite). This difference is taxed as regular income immediately, even if you haven't sold the shares yet! You pay real cash tax on "paper" gains, which can be a significant deterrent to exercising.
Why Exercise? (Capital Gains): Despite the perquisite tax, exercising starts the clock for capital gains tax purposes. If you hold the shares for more than 24 months after exercising (for unlisted shares), any profit upon selling is taxed as Long-Term Capital Gains (LTCG), which is generally lower (~12.5% + surcharge) than Short-Term Capital Gains (STCG). STCG is taxed like regular income (potentially ~39.5% in the highest bracket). LTCG might also offer benefits like offsetting against buying a house (subject to conditions), potentially leading to zero tax. However, most employees delay exercising until a sale is certain to avoid the upfront tax hit.
Post-Exit Exercise Window: What happens if you leave the company? Policies vary.
Old Model: Often required exercising vested options within 90 days of leaving, or they lapse. This pressured employees to exercise (and pay tax) or lose their earned options.
New Trend: More employee-friendly companies offer longer exercise windows (sometimes 5-10 years) after leaving, allowing ex-employees to wait for a liquidity event without forfeiting their options. Satish suggests 5+ years is a good employee-friendly mechanism.
Now that we understand ESOPs, a significant challenge emerges: while potentially valuable, they often remain "paper wealth" for years. How can employees access the value they've helped create before a distant IPO or acquisition? This is where Hissa comes in.
Introducing Hissa: Unlocking Private Market Liquidity 🔑
Hissa, founded by Satish Mugulavalli, is a platform designed to bring liquidity to India's private markets. Derived from the Hindi word for 'share', Hissa facilitates quick, tech-driven transactions between companies, shareholders, and investors, with a special focus on solving the ESOP liquidity problem.
Beyond VCs: The Expanding World of Private Market Liquidity
Traditionally, liquidity in private startups meant VCs buying out angels or PE funds buying out VCs. The ultimate liquidity event is usually an acquisition or an IPO. However, as Indian startups stay private for longer – fueled by large capital inflows – the need for intermediate liquidity solutions has grown dramatically.
"Companies are staying private longer... one area that completely gets ignored is employees. What happens to these employees?" - Satish Mugulavalli
While founders often get liquidity at IPO, and venture investors can sell stakes to larger funds, employees holding ESOPs are often left waiting, holding onto valuable, yet illiquid, 'paper wealth'. Hissa saw this gap as a significant opportunity.
The Hissa Thesis: Investing in Growth Stage ESOPs
Hissa operates a SEBI CAT II AIF (Alternative Investment Fund) specifically targeting ESOP liquidity. But what's the pitch to their Limited Partners (LPs)?
Target LPs: Individuals in the startup ecosystem (founders, wealthy individuals), and family offices undergoing generational wealth shifts.
The Gap: Many investors participate either at the risky angel stage or the late pre-IPO stage. Hissa offers access to the growth stage (Series B and later), which is often inaccessible, especially for smaller check sizes.
Risk Profile: It's less risky than angel investing but offers potential upside before a company potentially goes public.
Investor Check Sizes:
Minimum Investment (Regulatory): ₹1 Crore.
Startup Ecosystem Individuals: Typically ₹1 Crore to ₹5 Crores.
Family Offices: Typically ₹5 Crores to ₹15 Crores.
"We are getting in at a slightly more mature stage of a company... thereby it is not as super risky as Angel Investing and then we look at exiting closer to the IPO." - Satish Mugulavalli
Hissa Fund 1 Status:
Target Size: ₹150 Crore base + ₹150 Crore Green Shoe option (allowing up to ₹300 Crore total without needing new SEBI approval).
First Close: Completed at ₹30 Crores.
Pipeline: Another ₹100 Crores targeted for closure this year.
Average Ticket Size (Early LPs): ₹1 Crore to ₹5 Crore range, primarily from the founder community.
India's Family Office Boom: A Growing Appetite for Startups 📈
Convincing family offices requires understanding their existing asset allocation and mindset. Satish notes a significant shift:
Market Size: Estimates range from 600 to 2000 single-family offices in India, many managing upwards of ₹2000 Crores across assets. These aren't just in metros; significant wealth exists in smaller towns.
Generational Shift: The next generation often shows a greater interest in private markets/startups compared to traditional businesses or real estate.
The Pitch: Hissa positions itself as access to growth-stage companies that might be missed otherwise, potentially serving as an entry point for future, larger direct investments by the family office.
Reaching these LPs? Satish confirms: "It's absolute sales job... Any venture investing is a sales job on both sides. You sell to the company to take your money, you sell to the investor to take their money".
Sourcing Equity: The Tech + Touch Approach 🤝
How does Hissa find the ESOPs to buy? It's a blend of technology and traditional VC networking.
The Vision: To be a "private market transaction engine," not just a capital provider. The goal is T+5 settlement (check in employee hands within 5 days of them opting for liquidity).
The Tech Platform: Hissa offers software for companies to digitize and manage their equity. Adoption of this software becomes a deal-sourcing channel.
The Traditional Play: Tracking target companies, outbound calls to founders, educating them on the benefits of periodic ESOP liquidity before they need it. This involves convincing founders that offering liquidity helps rationalize compensation costs and retain key talent.
"The manager doesn't pick the asset. The asset picks the manager." - Satish, quoting Karthik Reddy
Ultimately, Hissa wants founders to proactively seek them out for employee liquidity solutions.
Targeting the Sweet Spot: Which Companies Qualify? ✅
Hissa applies financial discipline to its investment strategy.
Stage: Early growth (Series B and later). Providing liquidity too early (e.g., Seed stage) doesn't make sense as the company itself hasn't grown enough.
ESOP Aging: Focus on employees who have held ESOPs for 3+ years, indicating commitment. Liquidity is typically offered on a small percentage of vested ESOPs.
Funding Momentum: Companies should still be successfully raising capital, demonstrating growth potential. Raising venture debt is seen as a positive signal due to the rigorous due diligence involved.
Valuation: Primarily $100 million to $300 million range. This range currently includes roughly 200-300 companies in India. This is considered the sweet spot before valuations potentially become too expensive for their fund thesis.
Valuation & The "Secondary Discount": Reality Check 📉
How is the purchase price decided?
Anchor: The last primary funding round's valuation serves as the anchor.
The Norm: Discounts are common in secondary transactions, typically ranging from 10% to 40%. Satish believes up to 20% is generally fair.
Why the Discount?
Secondary capital doesn't go into the company for growth; it provides liquidity to an existing shareholder.
It reflects the "illiquidity premium" inherent in private markets being removed.
Seller's need for timing/liquidity.
ESOP shares are often plain equity without investor preferences, placing them lower in the liquidation stack.
Avoiding Negative Signals: While discounts are normal, Satish emphasizes not shortchanging employees. Discounts exceeding 15-20% might signal issues like previous overvaluation or distress, requiring careful consideration. Transparency is key, often aligning employee secondary prices with what other investors might be getting.
"You're providing liquidity and therefore it is reasonable to ask for a discount... Anything up to 20% I think is fair game for everybody." - Satish Mugulavalli
India's dedicated secondary market is nascent but growing, with funds like Kendra Capital and Oyster emerging. Hissa fits into this category but with a specific focus on ESOPs and early angels. Satish frames it less as "taking advantage" and more as enabling the ecosystem – helping companies retain talent and giving employees meaningful wealth creation opportunities before an IPO. A small liquidation of, say, ₹25 lakhs from a ₹2 Crore ESOP holding can be life-changing for an employee, perhaps paying off a home EMI.
Building the Rails: Why the Tech Platform Matters 🏗️
Why build a SaaS platform when the target fund market seems addressable through relationships?
Long-Term Vision: Hissa aims to build the infrastructure for private market transactions in India, akin to a "NASDAQ Private Markets" for India. The fund is just the first step, seeding the market.
Efficiency & Scale: Digitized equity and streamlined workflows are crucial for achieving the desired speed (T+5) and scale, which manual processes can't match. Learning from public markets (NSE, BSE, CDSL, NSDL enabling T+1) shows the power of infrastructure [cite: 1114-1120, 1131].
Future Marketplace: The platform could eventually allow third-party capital providers to discover assets and facilitate transactions, moving beyond Hissa's own funds.
Necessity: This infrastructure doesn't currently exist robustly in India, so Hissa had to build it.
"The vision is how do we enable private market transactions... without having a very strong tech built layer, you will not be able to do it in the time frame and the efficiency that you want." - Satish Mugulavalli
Satish believes the platform (the "AMC") will ultimately build more value than any individual fund ("mutual fund scheme") they manage. They might launch other funds (pre-IPO, early-stage) but also want to enable other capital providers.
The rise of platforms like Hissa signifies a maturing Indian startup ecosystem, acknowledging the need for structured liquidity solutions beyond traditional VC exits. By combining an understanding of ESOP complexities with a tech-driven approach and focused fund, Hissa aims to unlock significant wealth for employees and provide new avenues for investors, ultimately building the infrastructure for a more dynamic private market in India.
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