Accepting a startup ESOP? Here is all you need to know

An acronym for Employee Stock Option Plan, ESOP is no more an alien term in the Indian startup ecosystem. Earlier ESOPs were offered to reward and acknowledge the contributions of senior employees, now they are offered to reduce the fund-shed or to give employees a sense of ownership and, thus, a bigger responsibility. For starters, ESOPs refer to plans that give employees the right to purchase a certain number of the company’s shares in lieu of salary. This gives them a virtual stake in the company. The risk factor on the founder’s shoulders is also reduced a bit.

Various companies like Flipkart, Skype, Facebook and Amazon have for long been offering ESOPs to its employees and an increasing number of Indian startups are following the suit. There have been numerous cases of startup ESOPs turning into huge fortunes with time. Initial employees from companies like Facebook who worked solely on ESOPs are now billionaires. But, with   claiming that nine out of 10 startups end up as failures, accepting ESOPs becomes a gamble. Like gambling, the outcome totally depends on the way you play it.

Here are a few things to be kept in mind before accepting ESOPs from a startup:

Vesting period: ESOPs are NOT SHARES. They are structured in a way that the option to buy shares at a discounted price can be exercised only after a certain vesting period. The vesting period is usually up to 4 years. In case a person quits or gets fired before the vesting period, the ESOPs are lost.

Tax calculations: ESOPs are considered as part of an employee’s perks and taxed accordingly. But it is important to understand that if you were to dispose the shares, the difference between the sale price and the fair market value will be subjected to personal capital gains.

Scope of the startup: Given the way startups are moving in and out, evaluate whether the company has a scope to stay in market for a period of at least four years. It is important to know the scalability of the idea before accepting ESOPs from an early stage startup. Consistent bad performance of the company might also be a risk to the value of the ESOPs. The best way to deal with this is to limit the amount of stocks that you can buy.

Awareness of chances: Remember that you will be having ESOPs of a startup and not a listed company. There are quite a few chances of cashing out till the company goes public. Acquisition would be beneficial, but that is again a chance-game. In case of acquisition, the stocks get transferred to the acquiring company and the ESOP holders will be allowed to encash a portion of their holdings.

Money matters: Although ESOPs aren’t really considered as a cost to company (CTC), remember that you are sacrificing a part of your salary in the name of ESOP. Since you are not a direct owner, it is no harm to evaluate between the two options--a good CTC or CTC plus ESOPs. Take a step that you won’t repent for all the hard work you are going to offer.

Agreement terms: It is important to go through the agreement terms thoroughly before signing them. Few years ago, when Skype laid off a few employees, they weren’t able to keep even the vested portion of their stocks. This, apparently, was done as per one of the clauses in their Management Partnership Agreement, which none of the employees would have even noticed while signing.

Accepting ESOPs is like buying a lottery ticket. They are equal chances of both winning and losing. The excitement and scope that exists in a startup job makes it worth the risk.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)