All You Need To Know About ESOPs!

Updated: May 20

A slew of Indian startups are looking to outcompete their peers by retaining and acquiring quality talent through Employee Stock Ownership Plans (ESOPs) these days.

 

New age Indian startups are bending backwards to ensure that they offer the best deals to hire quality talent and retain valuable employees even amidst an exceedingly competitive market, where tech companies are always looking to poach skilled talent from peers.


Employee stock options is a tool which is used the most while building an attractive compensation package for employees. This also allows them to make their employees a partner in the company’s growth. 


Image credit: Entrackr


Around 32 startups have spent at least Rs 3,000 crore in the last 12 months to buy back ESOPs, according to a recent analysis by VCCircle. 


What are ESOPs?


An ESOP is an employee benefit plan that offers employees a chance to own a part of the organisation with a common equity share. The package is usually issued as a bonus profit sharing plan, or as direct stock. 


Such a plan provides the company, which is the selling shareholder here and the employee several tax benefits. It is also used as a means to align the interest of the employees with those of the shareholders. 


How do they work? 


Organisations usually offer ESOPs over a period of time, commonly known as the vesting period. During this time frame, employees cannot convert them to shares or sell them. However they can accumulate their ESOPs in the specified period according to pre-mentioned milestones and their grant letter. 


For example after four years of service, your startup may reward you with 0.1% of the company’s share capital as ESOPs. After they are vested, you can deposit these shares into your demat account and sell them. 


How to create an ESOP plan?


As a startup you can now use a single streamlined platform to design an ESOP plan for your employees. Platforms such as Qapita, Carta, Pulley, Vestd and Ledgy are among some of the better used equity management software to create an ESOP plan. 



While a company must always consult with their legal team to tailor their ESOP packages, these platforms offer templates that can be a great place to start. 


Timing is crucial


The fintech startup CRED recently announced that employees who have finished 1 year with the company could take half of their annual cash compensation as “special grant ESOPs,” which would vest after one year.


“ESOPs are no longer just a paper asset. If you have shares vested up to yesterday, you can sell it today. If you are leaving the company and you don’t know what happens to your shares, you can take cash and go home,” said Vivek Gupta, co-founder of Licious. 

There may be a stipulated lock-in period, but this varies from one company to another. This is just to ensure that employees do not sell their shares as soon as they get them. 


It is always recommended that organisations remain transparent about when the next round of funding is, so that it is easy for the new investors who buy the employees’ ESOP to infuse fresh capital. If your vesting period is too long, you may miss out on cashing out during the funding round.


How to vest during an IPO?


If your company is going for an IPO listing soon, it is usually a good time for investors and employees to sell their stock. Once it gets listed, you can sell your stocks in the open market. 


Image credit: Markus Winkler, Unsplash


However, at times, the company executes a lockup period that can prevent employees from selling their stocks. Once the lockup period is over, the shares under your ESOP package will appear in your demat account. It is advisable that you keep tracking the stock so that after the lockup period, you know how high it can go, in order to establish a good selling price. 


The ESOP boom


ESOPs also help startups to have higher valuations in the market. The ESOP boom among corporates can also be justified using this. 


Motivated by their fundraising, several Indian startups today including Flipkart, Acko, Unacademy, PhonePe, Meesho, Cred, Licious and UpGrad, have created buyback schemes this year. 


"Next time I am hiring a person, that person may himself say - don’t give me only cash; give me a combination of stock and cash," Gupta told Mint.

Negotiating employee stock option programs in your salary 


If you are offered an ESOP plan in your salary package, it is crucial to first understand how much the equity is worth and what percentage of the company’s value it holds. For example, if you are offered 0.1% equity, the value of it will vary depending on the company’s valuation and its outstanding shares. 


If you have over 5 years of experience in your professional field, then you can also bargain on what your vesting period should be. Companies usually have longer vesting periods to ensure that employees stay longer and accumulate more options. 


And, if you are someone who joined the company during its early days, then you can negotiate a higher price for the equity allotted to you, when compared to the ones who have joined much later. 


Win-win situation


All in all, ESOPs are beneficial for employees as well as the employers. Swiggy and Zerodha were the biggest fortune creators for their employees in 2020. They bagged a total of $9 million worth of buyback each in 2020.


Generous buybacks during the funding cycle is like a treasure both for companies and their employees. One in three startups that announced ESOP buybacks in 2021, became unicorns. Around 12 Indian companies including FirstCry, Swiggy, Urban Company, Zerodha and Meesho bought about $50 million worth of ESOPs from their employees in 2020, notes Entrackr.


 

Edited by Roshni Shroff

Cover image illustration by Jyothi Syam

 

Some resources to help you get a better idea about ESOPs:

Decoding ESOP for Startups


How start-ups are using ESOPs to attract and retain the best talent