Unlocking the Power of ESOPs: How They Can Change Lives and Fuel the Startup Ecosystem

When Employee Stock Option Plans (ESOPs) work well, they’re not just a perk—they’re a life-changing opportunity. Take Swiggy’s recent IPO, where around 5,000 employees collectively earned ?9,000 crores. Some walked away with over ?100 crores, and many made upwards of ?10 crores. This kind of wealth empowers individuals to dream bigger, take risks, and even start their own ventures, creating a ripple effect that strengthens the startup ecosystem.

If you’re considering an offer from a startup that includes a significant ESOP component, it’s essential to know what to look for. For ESOPs to truly create value, two key factors need to align:

1. Growth in Company Value
2. Employee-Friendly ESOP Policies

Let’s break down how to evaluate each of these factors.

1. Growth Potential: Think Like an Investor

When considering ESOPs, it’s crucial to adopt an investor’s mindset. Just as investors weigh valuations carefully, employees should consider the company’s current valuation when assessing the potential for ESOP growth.

For instance:

• If you’re joining a startup valued at $100 million, there’s a much greater chance of seeing a 10x growth than if you’re joining a startup already valued at $5 billion.
• A ?75 lakh ESOP allotment in a company valued at ?1,000 crore with high growth potential may end up being far more lucrative than a ?2 crore allotment in a ?20,000 crore company with limited growth upside.

Additionally, consider the business model and market potential—especially if you’re joining a Seed, Series A, or Series B stage startup. Look into whether the company’s model is sustainable, scalable, and positioned to grow within its industry. Early-stage startups with innovative products and strong leadership can offer tremendous upside, but they also come with greater risk.

2. Employee-Friendly ESOP Policies

Unfortunately, not all ESOP policies are created equal. Even if the company is successful, employees sometimes miss out due to unfriendly ESOP terms. Startups like Swiggy and Zomato are known for their employee-centric ESOP policies, setting an industry standard. Here are some critical ESOP policy features to look out for:

a) Vesting Schedule

The most common vesting schedule is 25% per year, meaning you gradually earn your shares over four years. However, watch out for back-loaded schedules, where more shares vest in later years—this can be a red flag, especially if you’re uncertain about long-term tenure. Also, be cautious of performance-linked vesting; it’s the company’s responsibility to manage performance, not to use ESOPs as a performance metric.

b) Vesting on Leaving or Company Exit

If you leave the company, you should ideally retain all vested options. Additionally, if the company gets acquired before all your options vest, there should be an accelerated vesting clause to ensure you don’t miss out on significant gains.

c) Clear and Transparent Communication

All ESOP terms should be clearly documented in writing, ideally through a dedicated ESOP portal where you can monitor your vesting status. Verbal commitments or undocumented promises are a red flag and can lead to misunderstandings down the line.

d) Strike Price

The strike price (or exercise price) is the amount you pay to convert your options into shares. The lower the strike price, the higher your potential gains. Ideally, the strike price should be as low as possible (?1 is ideal), allowing you to maximize the value of your options as the company grows.

e) Holding or Exercise Period

One of the biggest challenges with ESOPs is the tax liability. Exercising options often incurs taxes of up to 40% on unrealized gains, which can create a significant financial burden if the shares aren’t immediately liquid. Ideally, you should look for an infinite exercise period for vested options, even after you leave the company. This allows you to wait for a liquidity event (like an IPO) without paying taxes upfront.

Why ESOPs Matter for the Startup Ecosystem

When structured well, ESOPs are a powerful tool, not just for employees but for the entire startup ecosystem.

They create wealth, inspire entrepreneurship, and fuel the next generation of founders. Employees with life-changing earnings often reinvest in the ecosystem, either by starting their own ventures or by funding new startups.

This cycle of innovation and wealth creation is a critical driver of growth, especially in emerging markets.

So, if you’re evaluating an offer with an ESOP component, take the time to understand both the company’s growth potential and the ESOP terms.

With the right alignment, ESOPs can be transformative, empowering you not only to achieve financial independence but also to contribute to the larger wave of entrepreneurial innovation.

By making informed choices, you can unlock the full potential of ESOPs—transforming both your life and the startup ecosystem.

If you are planning to setup ESOP policies and implement it in your Organisation, connect with CA Mayank Wadhera ????