ESOPs, a common and yet misunderstood term among recruiters, employees and companies, is widely in talks these days. ESOPs give company owners tax-efficient means to sell all or part of their shares to their employees, on a timeline of their choosing.
Companies have the added benefit of equipping employees to increase sales and profits as these employees become “owners.” The employees get beneficial ownership, while the selling shareholder retains control. But how should companies plan their ESOP and salary distribution in the various stages of growth? Let’s take a look.
- Early Stage – Go for aggressive ESOP play
In the early stages (with seed and angel rounds in their kitty), companies have reduced liquidity of cash. They usually do not have adequate resources to hire C-Suite executives and other employees who are critical to business growth. In such cases, founders should offer ESOPs aggressively and lower cash components. ESOP grants can be heavy, and the policies flexible. Attracting employees for the long term is the main intention in this stage. - Growth Stage – Choose aggressive cash play
If a startup has raised a Series A or B round, it means the business has grown. Founders, ideally, should try to match the cash expectations of employees and restrict ESOP distribution to those employees who are highly valuable. ESOP grants can go down, and cash components should rise in this case. ESOPs can also be offered to employees as rewards/bonuses.
In this phase, the main goal is the retention of out-performing employees. Employees who were not given ESOPs on joining must be offered equity options now, provided they are a valuable resource to the organization. In the growth stage specifically, founders should leverage ESOPs to solve their business problems, that is, they should make the right hires! Founders must also remember that ESOPs at this stage have high valuations. Hence, offer ESOPs when it is of utmost necessity only. - Maturity Stage – Balance out the ESOP and cash play
After raising a Series B round, startups are considered to be in a mature stage. In this later stage, both the cash component and the ESOP pool are almost balanced. Here, founders must increase ESOP grants allocated to performance.
As the cash component is high, ESOPs should only be given when necessary. It is also important to know that in later stages, since the valuation of the company is high, the Fair Market Value (FMV) of each ESOP would also be very high. For this reason, it is important for founders to have a balanced view of the rewards that are to be offered to employees for performance.
Many unicorns today have been built on the foundation of a strong and well-strategized ESOP policy. It is imperative thereof that founders understand ESOPs thoroughly and incorporate them substantially to foster a positive work culture.
It is also important to understand that stock options are a combination of the founder’s motives of profit and private ownership, and the desire of employees to have a share in the wealth they help create. A wisely and thoroughly strategized ESOP plan can be the silent route to success in the startup’s success story.
To wrap up, it is also fundamentally instrumental to make sure that your employees and advisors understand the ESOP policy of your organization in all its variations. Make sure that they’re given proper documentation in writing as well as training on the ESOP policy.
They should have full clarity on what’s in for them, how they can benefit, what triggers tax consequences and what happens if certain events, voluntarily or involuntarily, occur. These are a few insights we were glad to hear from Satheesh KV, COO at Spottabl at a webinar.
