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ESOPs for Dummies: All about retention instruments for startups

Last month a startup came to us for company incorporation with three promoters in a state of India. They said they want to create an ESOP pool right now in order to offers Employee Stock Options (ESOPs) to their employees without knowing what are Esops and how they will use this term to promote their startup.

Last month a startup came to us for company incorporation with three promoters in a state of India. They said they want to create an ESOP pool right now in order to offers Employee Stock Options (ESOPs) to their employees without knowing what are Esops and how they will use this term to promote their startup.

Let us understand this situation by the help of Info graphic:

 

Employee Stock Options were never as famous as they are now days, thanks to all the startups who are putting their every effort to make their venture successful. Traditionally, ESOPs were to remunerate their senior employee to acknowledge their contribution to the company.

 

However in modern days, ESOPs are used as a consideration by the founders to get their work as done as they can’t afford to shed a few thousand dollars in the beginning. Also, ESOPs are very much also used to retain the key employee in the organization.

But before coming to how startup should go for esops we should understand

What Esops are:

Employee Stock Option Plans are the plans in which employees got the right to purchase a no. of shares (decided by the employer) in the company at a discounted price less than the market price, on the basis of their performance, and also it is the sign of motivation for the employees to keep increasing their performance.

Also In this Employees should have to wait for a certain period known as vesting period before they can exercise the right to purchase those specified no. of shares.

 

Benefits of ESOPS

 

  • Retainership Instrument

Esops can be treated as retainers instrument for small business as in this option there is lock-in period for exercising the right to purchase the shares, so a business could retain its employees up to the lock-in period as because if an employee opts for this option then he has to serve the lock in period to become eligible to exercise this option.

 

  • Ownership feeling for Employees

As if someone getting shares of the company in which they are working it gives them an ownership feeling that now they are not employees of this organisation but are the owners.

Also, they got the right to share the profits of the company in the form of dividend and always motivated to work for the best of the company.

 

  • Option in lieu of Salary

Business who needs funds and who are not in a position to spent hefty of amount can offer this option its employees in lieu of salary and motivated their employees to work for the betterment of the company.

Dark Side of ESOPs

However, like every coin has two sides, ESOPS also has a darker side which is dilution, in other words, with every ESOP is granted, the shareholding of the founders gets diluted. Let us understand the whole concept and idea about the ESOPs.

Conclusion

While established companies use this option as a retention tool for their top assets/brains and on the other side Startups use it as a tool to hire good talent, as they cannot afford to pay very high salaries. What makes an Esop attractive, other than the value or potential value of the shares or units, is the idea of ownership it imparts to the employee holding it and also working of Esop concept also depends Only if the company is in a high-growth sector will Esops see an actual rise in value of the business.




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