The growing strength of the start-up ecosystem has led to the dawn of a new age in employee compensation strategies. Start-ups are an innovative lot and the innovation isn’t restricted to their product or business structure. It trickles down to every aspect of the organization, including employee compensations.
The basic premise of employee motivation is simple. People work better if they are emotionally (and financially) invested. ESOP is a means to share ownership with the employees, intended to act as a motivational mechanism.
An ESOP plan is now an accepted approach to incentivize employees. As is widely acknowledged now, ESOPs have widespread benefits like;
- Monetary rewards, linked to the employee and organizational performance involving both long term and short-term achievements
- A sense of Ownership/Stakeholder and association with the enterprise
- Improved awareness about the larger picture here, what is at stake, and the directions and corporate plans of the enterprise
- Smoother communication between Founders/Promoters/Senior Executives and the employees
- ESOPs can also be part of the employee engagement program thereby encouraging employees to play a larger part in the development and disruptive innovation
Employee Participation in ESOP – Challenges
From a recruiter’s point of view, ESOPs are a key hiring tool that helps attract a rich pool of talent without having to pay heavy pay packages. This in particular is an advantage for start-ups that aren’t well funded, but the strategy could fall short if the employees are still sceptical. While ESOPs are beneficial for the employees, there is always a flip side to consider. ESOPs have been the subject of scepticism in the minds of the employees due to outdated perceptions, a lack of awareness, or reduced trust. It is also true that if not structured properly the entire program can go wrong and add to such apprehensions.
Even though they are meant to incentivize employees by giving them a stake of ownership in the organization, some remain unconvinced since historically not many had cashed out. It’s clear that times are changing and several big-name IPOs with healthy ESOP components and a growing number of pre-IPO startups in the news for inclusive ESOP strategies are helping to change the perception. But even with that, changing entrenched perceptions takes time given that employees in Indian start-ups have earlier waited longer than other countries to see returns on their “investment”.
ESOPs add discernible value to an employee’s portfolio if there is precedence. If people have made money in the past, it adds credibility to the organization and proves how employee-friendly it has been in the limited duration of existence. But if that opportunity hasn’t arisen so far, to some extent, the problem here must be addressed with communication. If the startup is able to convincingly portray the value of the ESOP and how it translates into monetary benefits for the employees, they will be able to create resonance. This makes employee communication design, delivery, and diligence a crucial element to induce employee participation in the ESOP program.
It used to be that start-ups recruited employees at greatly reduced salaries from their current job by offering ESOPs as an incentive. While the salary paradigm is changing, especially in startups that have secured large funding rounds, many employees find it hard to place a monetary value on the ESOPs and hence don’t consider them “real”. They don’t have a transparent view of what their ESOPs can be worth, when those returns would become available, and what has to happen for them to be able to exercise their options. This suggests the need for a mechanism for the employee to have transparent visibility into the state of the ESOP, the development in the plan, current valuation, etc. It also indicates the need for employee training on the basics of ESOPs and of the financial market ecosystem in which they exist. Knowing what they “own” and how to get access to it, will help convince employees of the benefit of participating.
Shares are a volatile instrument. Sometimes employees are overexposed to the company’s shares and in the event of the company not performing, they believe that they stand to lose their nest egg. Add to that the constant market fluctuation, which can lead to a decrease in share value. As a result, employees feel they cannot control the share prices or performance indices and as a result, ESOP plans bear less value for them. While the economy is too large to control, it is important for the startup to let the employee know that the company is in the same situation as them. Having the assurance that as the company does well, they would do so too, will drive greater confidence. It is also important to communicate that the true value of ESOPs emerges only in the long term and for employees to know that ESOPs are meant to be long-term investment tools. In fact, employers should encourage employees to look at ESOP as a value addition rather than a mere alternative for cash.
Also, when it comes time to exercise the available options, some employees fear they may find themselves financially inadequate. There are instances where employees who wish to exercise the shares fall short of the necessary cash. Companies can form strategic tie-ups with banks and NBFCs to extend short-term loans to the employees to help them exercise their options. That apart, on an ongoing basis, the startup could focus on financial education and helping employees inculcate savings and investment habits that make them more financially robust. This will help their overall well-being, as well as make them better equipped to participate in the ESOPs when they do become due.
It is in the interest of the startup to have more eligible employees participate in their ESOP strategy and derive the promised benefits. As we have seen, that needs employee communications, training, and hand-holding, apart from the right systems and protocols. Let us show you how to make this a success.
