How ESOPs can become meaningful rewards in a startup employee's career?

“You need an employee who behaves like James Bond!
Such employees are invaluable assets”
Sam Altman, CEO, OpenAI & former President, Y-Combinator

Any startup success story today is built on the backs of these “James Bond” like employees, folks that are resilient and go beyond the call of ‘duty’ to deliver – engineers, marketers, managers that make the founder’s mission their own! Our conversations with several unicorn founders have revealed that their exponential growth is the result of hiring and retaining top-notch talent.

Today, high attrition is one of the biggest challenges founders face. Be it better job offers from competitors or a feeling of not being recognized enough or simply just burnout due to the fast-paced nature of work, employee attrition is a very real problem for founders and HR managers. To address this predicament, companies are in need of solutions that instill loyalty in employees. And a simple solution is the incentivization of employees from the get-go by making them co-owners of the startup. This is where ESOPs (Employee Stock Ownership Plans) take center stage.

Think of an ESOP as a long-term incentive scheme that is made available to early employees as a gesture of faith and with a promise for outsized returns. While the employer can minimize attrition, the employee gets steered toward the organization’s vision and, hence, continues to perform to the best of his/her caliber. But, how exactly do employees benefit from ESOPs?

As a wealth creation plan, an ESOP essentially gives an employee the option to buy a certain amount of company stocks (see FAQs) either at market value or at a discounted price.

Employees with ESOPs, therefore become potential stakeholders of the company. As per the stipulated time-frame defined in their ESOP scheme document, employees can actually buy the stocks that were once provided to them as an option. Post this, they can either monetize all or some of these stocks when the company announces a liquidity event like a buyback or secondary sale or an IPO (Initial Public Offering). This complete or partial monetization of ESOPs (if the startup has done well and has considerable valuation) will far exceed the standard remuneration of the employee. If an employee chooses to quit, before exercising ESOPs, the company generally buys back the stocks at Fair Market Value (FMV). In simple terms, ESOPs empower employees with a monetary edge.

A study titled ‘The Human Capital in the New Economy – Benchmarks and Best Practices 2019’ by Trifecta Capital, a venture debt firm, reveals that more than 50% of Series A startups have an ESOP pool larger than 7.5% when compared to an approximate 30% of growth-stage startups. According to the study, “Founders have excelled at articulating the proposition of ESOPs to attracting senior talent, while prospective talent is positively predisposed to seeking it.”

Deepak Abbot, a former senior VP at Paytm says, “ESOPs for long have been undervalued in India but many success stories of employees creating wealth through ESOPs and eventually building their own startups have slowly started to build a strong culture of wealth creation among employees.” Deepak himself is now taking the entrepreneurial plunge. Other notable examples of employees turned entrepreneurs are Sameer Nigam of Flipkart who went on to co-found PhonePe. Ankit Nagori & Mukesh Bansal of Flipkart who founded CureFit, Nitin Agarwal of Ola who co-founded Pianta, and ex-Flipkart employees Sujeet Kumar, Amod Malviya & Vaibhav Gupta who founded Udaan.

Sonu Iyer, Partner & National Leader – EY India, says in the ‘EY Annual Report for ESOPs 2019’, “Amongst different variants of share-based incentive plans, ESOPs remain to be the most popular amongst employees.” She further adds, “When offered to a carefully chosen set of employees and tied to objective criteria that are business relevant, ESOPs show a high delivery success.”

Here’s an example: The IPO of IndiaMART in July 2019 resulted in its ESOP-privileged employees earning millions. The company offered 4.89 million shares (at a face value of INR 10 each) on the NSE & BSE, and the issue price of each share was listed at INR 970-973. 10,000 shares were reserved for employees at a discount of INR 97 per share. The stock shot up 40% on listing and today the stock is trading above INR 2000 per share. A similar trend was observed when JustDial, QuickHeal, Info Edge, and Matrimony.com went public.

Even in privately held companies like Flipkart, PolicyBazaar, Blackbuck, RazorPay, and Unacademy that have had progressive ESOP policies and regular liquidity events, the wealth creation for employees has been tremendous. Recently, Razorpay offered an ESOP share buyback plan to 400 employees. As part of this plan, employees who hold ESOPs will be able to sell up to 30% of their vested shares at a premium. Both former and current employees made substantial profits due to this buyback plan (the actual numbers are, however, undisclosed!).

While companies are leveraging ESOPs as a retention tool and growth-multiplier, employees are benefitting in the overall process. To summarise, ESOPs pave a way for employees to:

Boost personal wealth (through equity ownership)
Grow professionally (as primary contributors)
Improve job security and satisfaction
Actively participate in decision making

As companies grow multi-fold, they understand the value of loyal employees. Offering ESOPs as a reward scheme, companies are able to retain employees whose performance is stellar and at the same time attract those who can be potential assets to the startups.

To learn more about ESOPs you can read our other blog on the strategy to create a strong ESOP Policy
If you are looking for an easy to use tool to create your ESOP policy and manage ESOPs for your team, check out MyStartupEquity