ESOP (Employee Stock Ownership Plans) programs have resiliently held on to their position as one of the popular employee reward schemes that drive long-term incentivization. Stories abide by how large organizations such as Google, Microsoft, and the like create significant differentiation and attract the best talent using their ESOP programs as a draw. But even beyond that, ESOPs help young startups and small organizations instill a sense of ownership in their target employees. With ESOPs, startups can strike a balance between compensating employees fairly while conserving the organization’s liquid resources as best as possible.
It’s a valued instrument because, while acknowledging stellar performance, ESOPs drive employees to become more committed towards organizational growth and invested in its overall performance. Research shows that organizations offering ESOP options increase their sales and employment by 2.3-2.4% annually every year. They also have a higher probability of staying in business longer.
In fact, ESOPs are a great way to retain a workforce effectively. While the economic principle of efficiency/wages lures the best candidates, salary inducements usually work only in the short term. ESOPs build equity ownership and align employees’ professional goals with that of the business. It becomes the impetus that employees need to work harder and take the organization to the next level.
However, many organizations think of ESOP programs as a one-time activity that ends when the plan is designed and announced.
ESOPS are mutually beneficial and generate more value for the organization. BUT, and this is a very big BUT, it all depends on how well these programs have been defined and how capable they are to flourish with agility as the organization grows.
ESOP programs need a solid strategy and agile framework to remain effective and relevant. So, what is the key to building an effective strategy for ESOP programs?
Build equity pools
ESOP programs can do a great deal more for the organization, as we have discussed earlier. As such, the rule of thumb while creating these programs is to create equity pools that benefit both the employer and the employee. The larger the pool, the more advantageous it is.
However, when ESOP programs are static, they do not build the right equity pools. Understanding the equity share and transparently calibrating it as the organization grows and expands, becomes essential to align ESOP programs as an incentive.
Agility drives relevance
The startup journey is quite complex and rife with challenges. However, when a startup moves from validation to growth, and the asset value of the organization increases, then stock option plans need to change as well. How can this be positioned as an incentive?
At the beginning of the startup journey, for example, founders need comparatively fewer employees than when it reaches the growth stage. The employees joining in the initial days are also shouldering as much risk as the founders. In all fairness, the return on their ESOP investment typically should be more than the employee who joins in the growth phase of the organization.
ESOP programs hence have to be agile and flexible to accommodate the ongoing needs of a growing organization and to effectively work for its success.
Consistency does not mean inflexibility
Successful ESOP programs are consistent. But consistency doesn’t always mean ‘fixed’ or ‘inflexible’. Such ESOP programs will not deliver much value. Growth is as important for ESOPs as it is for employees.
Ensuring the ESOP program remains consistently aligned and agile over the foundation, validation, and growth phases of the startup. Following this consistency helps in establishing the foundation of the plan and in evaluating what is working well and where the program needs to course correct.
Building a plan that is tailored to your business, industry, and revenue is also likely to deliver far more significant results. As such, copying equity plans of other companies or founders isn’t a great idea.
Along with this, startups must also account for the back-end work that optimally manages ESOP programs. This includes:
- Creating vesting schedules
- Designing and implementing processes that ensure that when employees leave the organization they return the unvested portion of their stock options.
- Employing robust plan administration that utilizes comprehensive technology platforms that aid data management and promote robust reporting
- Seamless processes that encompass all aspects of ESOP planning and management and connect all data points that relate to Planning, Execution, Taxation, and Compliance
- Managing tax calculations and reporting, options valuation, and related disclosures in financial statements (as required under IGAAP, IND AS, IFRS, US GAAP) effortlessly and accurately
The needs for startups, especially early-stage startups, are very different. While they want flexibility, at the same time, they need clarity and order. The absence of in-house expertise to roll out robust, comprehensive, value-driven legally compliant plans and manage them efficiently can impede the ability of any ESOP program to deliver greater organizational impact.
When designed well and offered as an employee incentive while being tied to an objective business-relevant criterion makes ESOPs a powerful incentivization tool. However, a great deal of the program’s success lies in how it is designed, implemented, and managed. As such, it wouldn’t be prudent to assume that once you have created and implemented an ESOP program you can be done with it. Implementing 21st century ready ESOP programs need more.
Organizations must design, structure, and implement ESOP plans following industry best practices. They must also ensure effective and ongoing communication on ESOPs and on financial performance and provide employees with the options to log in and view their accounts to grant documents, options, and valuation along with the flexibility to exercise and view their tax obligations. These approaches can help early-stage startups power up their ESOP programs and get them to deliver greater value towards employee engagement and retention.