June 8, 2020

Designing an ESOP policy: Know how to do it right

Designing an ESOP policy: Know how to do it right

Explaining ESOPs along with the offer is complicated. Your employees, both old and new, need to know that ESOPs are more than good-to-have retention tools. They are the wealth multiplier of the future. The future will be all about shared ownership; let your employees know the benefits that ESOPs can deliver.

But as founders, you have to play your cards well. As lucrative as ESOPs are, they involve dilution of equity for both, founder(s) and investor(s).

So, how do you roll out ESOPs in a way that covers both sides and does not leave money on the table for either. At ZenEquity, we have worked with some amazingly progressive companies for their ESOP journey, here is what we have learnt.

The key pointers that you have to keep in mind:

Know the law (and if you don’t, get someone who does)

There is company law, tax regulations, labour law, and a binding contract. The good thing about the law? Everything is in black and white. The bad thing - it is complicated. Also, a lot of things depend on where your company is registered. A lack of awareness around these laws can result in a far-reaching negative impact.

Get a consultant onboard who is an expert or get an external agency who guides you through this process. You need someone who understands the legal complications of both the parties, the company and the employee.

Culture fit above everything else

ESOPs cannot be a free pass for all. A good measure to remember this is to always be aware of the fact that every grant is dilution of ownership. Treat this as the base and define who makes the cut and who does not.

Do they see and align with your long-term vision? Will they sustain your culture? These questions are paramount and will help your ESOP policy. Your culture sustains your strategy and your business continuity plan. Pick people who fit in and will drive it ahead.

Don’t shelf-shop your ESOP policy

The best way to mishandle something is by following someone’s plan. You know what your company is and what your long-term goals are, use them to build your policy. Do not copy your competitor’s plan.

You have to account for your key growth pillars and build an ESOP policy that works on it. We have repeatedly learnt that what works is finding the policy that aligns with you and not the best policy out there. That is the reason, we advise you to build your ESOP policy from scratch. This plan should be flexible, employee-friendly, and should merge with your philosophy as an organization.

Communicate for clarity

Every single step you take in your company, specifically at the early-stage, needs to be driven by a narrative. You need to reason and justify because the story that leads to a decision is important. Remember, reassurance is the key and your employees seek it.

ESOPs are not a lucrative bonus, they are representative of accountability. Have one-on-one discussions with your employees. Talk to them about the business (business growth, expected next round of funding, exit plans, anticipated dilution, delayed profitability etc) and keep everything transparent.

Unit over value-it is a numbers game

Stock options are all about numbers. How much they are worth is just as important as how many. Example: Let’s say you offer ESOPs worth $20,000 to your early stage employees when you are starting, these will not be the same as ESOPs worth $20,000 five years later.

This is the reason you need to offer stocks in numbers because their value is not fixed. In all fairness, employees who took a greater risk by joining you at an early stage deserve more ESOPs. This does not mean that employees who joined at the growth stages do not deserve any. But the number of units should be the yardstick.

Distinguish ESOPs from the CTC

Do not use the ESOPs to leverage and negotiate CTC. Always treat them as a separate offering and avoid making them a part of the offered CTC. There should be a clear understanding on how salary works and a lower CTC with greater number of ESOPs is an equitable deal.

Communicate this to your employees. Employee stock options are not compensation. They are transfer of ownership and trust.  

At ZenEquity, we understand the significance of a good ESOP Policy. It is now crucial to have a clear ESOP plan. Use Employee Stock Options as a business strategy and make them a part of your growth. The policies you make now will shape your future as an organization.

To know more about how ZenEquity can help you craft your ESOP plan, contact us.