If you’ve recently joined a startup or are considering an offer, you’ve probably heard about Employee Stock Ownership Plans (ESOPs). While startups often don’t offer the same salary packages as large corporations, they compensate by offering equity in the company, giving employees a share in future success.
But what does that mean? How do you decide if ESOPs are a good deal or just empty promises? Let’s break it down in simple terms so that you can make an informed decision before signing any ESOP agreement and know more about startup equity.
To answer these questions, understanding ESOPs in startups becomes important.
By the end of this guide, you’ll have a clear understanding of ESOPs in startups and what to look for before accepting stock options.
What Is an ESOP and Why Do Startups Offer It?
An Employee Stock Ownership Plan (ESOP) is a program where a company grants employees the right to buy shares at a fixed price. These shares vest over time, meaning you earn the right to buy them only after staying with the company for a certain period.
Why Do Startups Offer ESOPs?
Startups usually don’t have the cash flow to pay high salaries like big corporations. Instead, they offer ESOPs as part of their compensation package, allowing employees to own a part of the company. This aligns employees’ interests with the company’s growth, making them feel like co-owners rather than just employees.
In simple terms, ESOPs are a way for startups to attract and retain talent while preserving cash. This is a common practice in the world of Startup Equity, where ownership is shared between founders, investors, and employees.
How Do ESOPs Work?
Understanding ESOPs in startups is crucial before accepting an offer. Let’s walk through the key steps:
1. Granting of Stock Options
When you join a startup, they may offer you stock options as part of your compensation. However, you don’t own these shares immediately; you have to earn them over time.
2. Vesting Period
The stock options vest over a specific period, meaning you earn the right to buy a portion of your allocated shares yearly. A common vesting schedule is four years with a one-year cliff, example:
You get nothing for the first 12 months.
After one year, 25% of your stock options vest.
The remaining 75% vests monthly or quarterly over the next three years.
This ensures employees stay committed to the company before they benefit from ESOPs.
3. Exercising Your Stock Options
Once your stock options vest, you have the right to exercise them, which means buying shares at a pre-agreed price (the exercise price or strike price). If the company's valuation increases, the difference between the market price and the exercise price becomes your profit.
Example:
Your startup grants you 1,000 stock options at an exercise price of ₹50 per share.
After three years, the company’s valuation increased, and the market price of the stock is now ₹500 per share.
If you buy the shares at ₹50 and sell at ₹500, your profit per share is ₹450 (₹500 - ₹50), making your total profit ₹4,50,000 (₹450 x 1,000 shares).
4. Liquidity Events (When You Can Sell Your Shares)
Owning shares is great, but you can’t always cash them out immediately. In most startups, you need a liquidity event—such as an IPO, acquisition, or buyback program—to actually sell your shares for cash.
If the company never reaches one of these milestones, your stock options may not have any real financial benefit. That’s why it’s important to ask the right questions before accepting ESOPs.
Key Questions to Ask Before Accepting ESOPs
Before signing an ESOP agreement, get clarity on the following:
1. How Many Stock Options Am I Getting?
It’s not just about the number of stock options but also what percentage of the company they represent. A grant of 10,000 shares sounds exciting, but if the company has 10 million shares in total, your ownership is just 0.1%.
2. What Is the Vesting Schedule?
Understanding ESOPs in startups means knowing when your stock options will vest and if there’s a cliff period.
3. What Is the Exercise Price?
The exercise price determines how much you’ll pay for your shares when you exercise them. If the exercise price is too close to the expected market value, you might not make much profit.
4. What Happens If I Leave the Company?
Many startups have a 90-day post-employment exercise window, meaning if you leave, you must buy your vested shares within 90 days, or you lose them. Some companies offer longer exercise periods, so it’s worth checking.
5. Are There Any Tax Implications?
ESOPs are subject to taxation, often at the time of exercising and again at the time of selling the shares. Understanding ESOP-related taxes in your country is crucial before making financial decisions.
6. Has the Company Had Any ESOP Buybacks?
A company that has conducted ESOP buybacks in the past is more likely to offer liquidity options to employees in the future. If there have been no buybacks, your shares might remain paper wealth with no real cash value.
The Pros and Cons of ESOPs
Pros
✔ Ownership in the company – You get a share in the startup’s success.
✔ Potential for high returns – If the company scales, your stocks could be worth a lot.
✔ Motivation and alignment – Employees feel more invested in company growth.
Cons
❌ Lack of liquidity – You may not be able to sell your shares for years.
❌ Complexity – Understanding ESOPs in startups can be tricky, with lots of legal terms.
❌ Tax burden – Exercising stock options may come with unexpected tax liabilities.
Final Thoughts
If you’re working at a startup or considering joining one, ESOPs can be a valuable part of your compensation package—but only if you understand how they work.
✔ Always ask questions before signing an ESOP agreement.
✔ Consider whether you can afford to exercise the options if required.
✔ Research if the company has a history of successful exits or buybacks.
In the world of Startup Equity, making informed decisions about ESOPs can help you build long-term wealth. Don’t just accept stock options blindly—make sure they align with your career and financial goals.
Find the Right Workspace to Grow Your Career
At Beginest Coworking Spaces, we provide a supportive environment for startup employees, founders, and professionals. Whether you’re discussing ESOP agreements, brainstorming your next big idea, or just looking for a productive place to work, Beginest coworking spaces in Indiranagar and coworking spaces in MG Road offer the perfect setting.
📍 Drop by or call 91080 29762 and explore Beginest coworking spaces in Bangalore. Let’s build something amazing together! 🚀
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