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Don't Launch an ESOP Plan Blindly: Essential Tips to Consider
Don't Launch an ESOP Plan Blindly: Essential Tips to Consider

September 7, 2024

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Don't Launch an ESOP Plan Blindly: Essential Tips to Consider
 

Author: Manish Panwar, Business Head at Vega Equity 

An Employee Stock Option Plan or ESOP is a financially driven plan to attract, reward, and retain good talented employees where the company issues a form of stock (ownership) in the company. To fully utilize an employee's full potential, it is important to recognize and motivate them. ESOP is an effective way to achieve this in a professional setting. By providing a tangible stake in the company’s success, ESOPs cultivate a sense of ownership, responsibility, and commitment among employees, aligning their interests with the organization’s growth. This alignment encourages a culture of mutual benefit and empowerment.
 

ESOPs are a powerful tool to engage employees and drive company growth. ESOP & Cap Table Management needs to become simpler now and we need an intuitive equity platform for fast-growing startups. By aligning interests, we empower everyone to reach their full potential. 


Below is the survey report detailing how the issuance of ESOPs contributes to the company’s growth: -

Source: KPMG in India’s ESOP Survey 2021

ESOP-issued companies have 25% higher retention than non-ESOP companies and they have enabled 17% higher performance compared with non-ESOP companies.

After understanding the benefits of ESOPs, it's important to address the challenges companies often face. These include choosing the right plan type, designing it effectively, and navigating legal and compliance issues

Things to know before launching an ESOP plan: 

1. Determine the Best Equity Scheme: To initiate the best route for launching an equity scheme, evaluate the various options available, including ESOPs, Restricted Stock Units (RSUs), and Phantom Shares. Each of these plans has its structures, benefits, and compliance requirements:

  • Employee Stock Option Plans (ESOPs) offer employees the option to own actual shares of the company, promote ownership in the company, and align their interests with the company's growth and vision.
  • Restricted Stock Units (RSUs) grant shares at a future date based on performance or a vested period, offering a guaranteed payout.
  • Phantom Shares promises to benefit the employees by rewarding them in the form of stock-like awards based on the company's stock performance without actual share issuance.

Assess which option best supports your company’s objectives and consult with compliance experts to ensure adherence to relevant regulations and tax implications. 

Here is a survey report that describes what equity scheme is used by a majority of organizations, which may help you understand it better.


Source: KPMG in India’s ESOP Survey 2021

2. Identify Employee Coverage: Establishing the total number of employees to be included in the ESOP is crucial. This decision influences the type of plan and benefits you can offer. Consider categorizing employees based on their roles, such as: 

  • Senior Leadership and CXOs: They should receive larger equity stakes due to their direct impact on company strategy.
  • Mid-Management: Could be offered a balanced mix of equity and cash compensation.
  • General Staff: A broader inclusion may enhance overall morale and employee engagement.

Understanding your employee demographics will help to map the ESOP to meet their needs and expectations.

3. Specificity in Plan Design: The ESOP should be more specific rather than generic. Establishing how you will measure the plan's success after specific intervals (1st year, 2nd year, 5th year) will involve parameters such as employee retention rates, performance improvements and overall company growth. These parameters should be decided by leadership at a company and stakeholders.

  • Employee Retention Rates: Track how the ESOP influences employee retention. Set specific targets (e.g., reduce turnover by 10% in the first year, 12% by the second year, and 18% by the fifth year).
  • Performance Improvements: Measure productivity increases among ESOP participants. Metrics might include increased revenue per employee and key performance indicators (KPIs) improvements.
  • Company Growth: Assess overall company growth linked to ESOP implementation, such as revenue growth, profitability and market share. For example, target a 10% increase in revenue attributable to enhanced employee motivation by year 3.

4. Benchmark Against Industry Trends: To ensure competitiveness, measure your ESOP against industry standards, including:

  • Research Peer Companies: Research the ESOP structures of similar industry companies. Focus on eligibility criteria, vesting schedules, allocation methods, and total share pool size.
  • Vesting Periods: Commonly range from 3 to 5 years. Consider what is typical in your industry. Ensure your schedule is competitive (e.g. a 5-year vesting period with a 1-year cliff is common).
  • Lock-In Periods: Determine how long employees must hold their shares before selling.
  • Exercise Price to FMV Ratio: Ensure the exercise price is set at a fair market value to incentivize participation without discouraging employees.

Understanding some of the benchmarks will help the company design an attractive and effective ESOP for employees that aligns with industry practices.

5. Legal and Compliance Considerations: Legal compliance is a key factor in launching an ESOP. Ensure that your plan adheres to applicable laws and regulations, including:

  • Securities Laws: Understanding the requirements for issuing ESOPs while considering both federal and state laws is crucial. Additionally, as a practice it is important to keep updated with the federal and state laws that could affect the company's ESOP program. 
  • Tax Implications: It is the most important thing to be aware of how different equity compensation types are taxed for both the company and employees.
  • Approval Processes: Some jurisdictions require shareholder approval before implementing an ESOP.
  • Consult with legal advisors: Engaging legal and financial advisors specializing in equity compensation can help navigate these complexities. 

6. Employee Communication and Training Plan: Effective communication plays a vital role in the success of an ESOP. Develop a comprehensive training and communication plan that includes:

  • Educational Workshops: By implementing the education workshops it will help employees to understand the legalities and benefits of the ESOP.
  • Regular Updates: Keep employees informed about the company’s growth and how it affects their equity stake.
  • Resources for Financial Literacy: Provide tools and resources to help employees make informed decisions regarding their equity compensation.

By addressing these considerations, companies can successfully implement an ESOP that not only incentivizes employees but also drives long-term organizational success. 

The Way Ahead 

The Employee Stock Option Plan focuses on employee engagement and company’s growth strategy to enhance the performance of the company. Investing in an ethical management system is a good idea for any company that aims to facilitate ethical operations. By following a comprehensive ESOP management cycle from crafting ESOP strategy to realizing wealth creation, throughout the ESOP lifecycle, companies can steer clear of complexities and challenges. This includes expert advisory on customized scheme design, followed by efficient automation on real-time metrics update, valuation and growth visualization, followed by good financing of funds which helps in cashless exercise and lowers your taxes.  

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About Manish Panwar

As Business Head of Vega Equity, Manish Panwar spearheads product development, strategic direction, and business development at Vega Equity. Since the launch of Vega Equity in January 2022, Manish has led a team of dedicated professionals who share a common vision of making ESOP and Cap Table management safe, hassle-free, and digitized for clients across industries. Connect with Manish via: https://www.linkedin.com/in/manish-panwar-83233467/

 


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Vega Equity is the go-to platform for comprehensive, digital, and secure ESOP and Cap Table management. Designed to support investors, start-ups, and employees, it streamlines the preparation and monitoring of stock option plans like ESOPs, Phantoms, SARs, and RSUs. It helps companies manage the entire ESOP lifecycle effortlessly, from grants and vesting to exercise and forfeiture. With Vega Equity, it is now easy and effective to visualize the Cap Table and dilution scenarios in one place, ensuring seamless control and oversight. Vega Equity makes digital equity management simple, efficient, and paperless. Find out more via the website: https://www.vega-equity.com

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