ESOPs: How to structure them in your company?
The money that Flipkart employees will make from ESOPs after the Flipkart-Walmart deal has caught everyone’s interest. But how can you, as a founder, leverage the benefits of ESOPs while building your team?
We conducted a podcast with Narayan Thammaiah from Accel to understand how ESOPs work for companies. This will help employers to understand how they should structure their Stock Options and employees to evaluate their ESOPs.
Narayan defines ESOPs as one of the components that organizations use to attract and retain talent. Some companies believe in providing this option when they are building up, some don’t. When asked about Vesting period for a startup, he states it one of the attributes of the stock option plan. An employee would get an opportunity for his/her tenure. And, number of options which the employee is given could range anywhere for performance units. Or, it could go on to 4 years for cliff vesting- linear vesting methods. Or, it could even be 5 years.
The balance between the cliff period and the vesting period is important because you wouldn’t want your stock options in the hands of employees who either leave in first 3-6 months of joining the organization or don’t have enough contribution towards the organization.
Best Practices to Build an Effective Stock Option Plan
The pattern needs to evolve during the course of the journey. You might make some decisions at the formation stage or early stage and the same thing needs to evolve as you go to the validation stage or growth stage. In the formation stage, you’ll probably have to attract 5-10 people who will be your early employees. Considering that they are taking a huge amount of risk by joining you, you need to compensate them through ESOPs in a much more rewarding manner than you would do at growth stage. Hence, starting the early stage, you should know your equity pool. You should identify what part of it you’re going to earmark for employee options.
As you move on to the validation stage, your ability to offer compensation would increase and your ability to offer equity will decrease, considering that there would be investors who have come in and employees you have hired.
So you need to structure it around the formation, validation and growth phases based on giving an early employee a bigger ticket to equity, a moderately bigger share in the validation phase and slightly lesser in the growth stage.
When Should an Employee Exercise Their Vested Stock Option?
If you have your unit at zero price, an employee doesn’t have to pay any prerequisite value of tax and can keep it. As and when you bring it to a monetary value, then the tax bracket would kick in. This means an employee would have to buy them the day he/she leaves the company.
The best case recommended for employees is seen to have 3-6 months for an option to exercise and buying it from the company. In case the employee is not really interested, it forfeits at the end of 90 day period. Once the employee buys in, it’s going to be available for the next 10 years.