ESOPs: Don't Let Your Employer Fool You

Employee Stock Ownership Plan (ESOP) is a benefit plan that gives employees company stock at low or no cost.

Indian startup employees of about 80 companies have made $1.45 billion through ESOPs since 2020, as per data compiled by Fintrackr.

However, what about the employees of other startups? Some employees complain of unfair practices being deployed by the founders while promising ESOPs.

Let’s discuss a few red flags you should be aware of w.r.t. ESOPs.

No Written Promise

An employee of a consumer electronics startup told us that he gave up a job in another company as the company HR promised him ESOPs to match the offer by the other company.

However, nothing was written in the offer letter. And now, as you can guess, the HR department told him that the board of directors is not accepting any further approvals of ESOPs.

Founders say that communication between the employee and employer w.r.t. ESOPs should always be written. Preferably, through the ESOP portal of the company.

Verbal communication doesn’t guarantee any kind of reward.

Unfair Conditions on Leaving the Company

A vesting condition of the ESOPs might involve paying for your options within 3 to 6 months of leaving the company.

Let us understand this clause with the help of an example. 500 ESOPs vest after the completion of each year and Mr. X has completed four years with the company. Now, he has 2,000 ESOPs with a strike price of ₹1,000 each.

If Mr. X has to resign now, he needs to arrange for ₹20,00,000 within 3 to 6 months; otherwise, all his vested ESOPs would lapse.

Moreover, as per prevailing tax laws, an employee might have to pay up to 39% tax on the vesting of his shares. A limited exercise window places a lot of financial burden on the employee. Thus, it is better if the exercise window is not limited by time, including in the event of an exit.

Individual Performance Linked ESOPs

Bosses can always point out your mistakes and say that you didn’t work hard enough, even if you had. If ESOPs are linked to your performance, which can be evaluated on the basis of your boss’s wishes, then he / she may unfairly evaluate your performance if they’ve been asked to cut down on the issuance of ESOPs due to pressure from founders or investors.

A social media user was in fact told that the vested ESOPs may get revoked in the event of "misconduct" by an employee. “Misconduct” is a very broad term, as he rightly pointed out, leaving his hard work to the whims and fancies of the founder to decide his fate.

Ideally, a company would give reasonable chances to the employee to prove his / her performance and put them on performance improvement plans if required. In cases of unsatisfactory performance, they ask employees to leave the company.

But where the employee is reasonably performing in his role, a company won’t ask them to leave. So why should the company cut down on the promise of giving ESOPs based on their ‘performance’?

No Accelerated Vesting in Case of Acquisition

Say your vesting conditions are such that your ESOPs will vest only after three years of staying with the company.

You do everything right in your job, stay loyal to the company and stay with the company through its ups and downs, but the company gets acquired after 2.5 years of you joining the company. In this case, your ESOPs won’t vest and all your hard work might go to waste.

To be fair, companies should always have a clause in place to ensure accelerated vesting in such events where the employees do not lose out even when the company makes more money.

Conclusion

The startup world is full of such stories that even after the company grew multi-fold and had many liquidity events, the employees made nothing despite giving their heart and soul to the company.

ESOPs can be a tool for enormous wealth creation; however, employees should be careful about certain clauses in the ESOP agreement to ensure that they are not shown the door when they ask for their rights.

Apart from all this, the employees should factor the founder’s past experiences and the potential in the idea before choosing between companies if they are banking on the ESOP part of their CTCs to create wealth in the long-run.