ESOPs – a powerful tool and valuable currency for startups

Employee Stock Options (ESOPs) is a powerful tool available to startups to attract as well as retain talent. However, often I have seen it being undervalued or under-utilised by startups.

ESOPs are shares that are given to employees so that they can enjoy significant monetary benefits if the startup is successful. Since the monetary value of selling equity of a successful startup can be several times higher than the salary, ESOPs alter the risk-reward equation and makes it attractive for potential employees to consider joining a startups, which otherwise at just salary levels may not be such a lucrative option.

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ESOPs are especially useful when startups or early-growth stage companies have to hire senior talent with experience, and they don’t have monies to pay full market salaries.

In fact, investors too encourage founders to carve out an ESOPs pool – often between 5 – 20% of the equity depending on how well balanced the existing founding team is. If the team has gaps that need to be filled in, it is important to carve out a higher percentage of equity, as that will allow you to hire the right resources to complete the team.

As an entrepreneur, it is important for you to communicate the ‘value’ that your enterprise is likely to create and thus explain to potential employees the potential value of the stock they are getting under the ESOP. If the company is successful, the stock can provide a significant upside to employees.

Not just in hiring, but ESOPs can also be a very useful retention tool. That is because a well-structured ESOPs plan ensures that the equity is vested over a period of time (i.e. it is given to the individual in instalments spread over a period of time), and if the startup is successful, the individual is incentivized to stay on even if there is a matching salary offer from another company.

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Author: Prajakt Raut

Prajakt Raut is the founder of Applyifi.com, and author of the book for startups - ‘Starting Up & Fund Raising’ Prajakt personal goal in life is to encourage and assist a 100,000 people to become entrepreneurs. _____________ Prajakt is the founder of Applyifi - an online platform that provides startups a 36-point scorecard and assessment report on the venture's investment readiness [www.applyifi.com], and helps them improve their odds of getting funded. Prajakt is also the founding partner of The Growth Labs, a platform where growth-stage companies get sharp, incisive advice from senior professionals and experienced entrepreneurs. [www.thegrowthlabs.in] Before starting Applyifi, Prajakt was the head of operations at IAN, founding member of a leading incubator, and the Asia-Director for TiE (2004 - 2007). Previously Prajakt had co-founded Orange Cross, a healthcare services company, and was part of the founding team member of Idealake Technologies. While in college Prajakt had founded a printing business and has spent over 10 years working in leading advertising agencies. Prajakt’s book, ‘Starting Up & Fund Raising’, helps startups understand an investor’s perspective, and helps them improve their odds of getting funded. The book also helps entrepreneurs understand the building blocks of a business.

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