Written by 10:11 am People & Culture

What makes a strong ESOP plan and how to provide it?

“ESOPs is my biggest rewards lever, but people still consider it paper money!”
“I have an ESOP plan, but I’m not sure if it’s progressive enough…”
“Do my leaders and team members have the right amount of ESOPs?”

If these concerns sound familiar, you are not alone. Based on our deep work on ESOPs with 25+ startups, 100+ founder roundtables, and eNPS surveys with 10,000+ employees, the following are seven core fundamentals that ensure a strong and progressive ESOP plan:

  1. Whom to give and how much to give—having clarity from the get-go

    There’s no real right answer to the ‘whom’ question. Let me illustrate by quoting two founders:

    Everyone should have skin in the game. Disproportionate rewards for impact creation.”
    -Founder, fintech unicorn with 100% coverage

    It’s ultimately about locking in and taking care of the top 100 employees who make decisions for the company.”
    -Founder, e-commerce unicorn

    They may have distinctly different approaches, but what these founders share and have a headstart on is a clear vision. This kind of clarity from the get-go resulted in clear mechanics and allocation frameworks, as well as effective communication—all of which are key to any healthy ESOP plan.

As for how much to give—it really boils down to the balance between your cash and
equity. You could choose to have a p.50 (50th percentile benchmark) on cash with a
p.90 on ESOPs, or a p.75 on cash with a p.50 on ESOPs. At the same time, it is
critical to get your total ESOP pool size right. A good litmus test for this is to
ask yourself: Do I have enough ESOPs for the next 2-3 years based on my
hiring plans?

*The median pool size in the ecosystem is ~10%. There are companies with a pool
size as big as 20% and as small as 0%.

  1. Think beyond joining equity—design for top-ups along the employee journey

Performance-linked top-ups (PL grants) are a great way to reward impact and potential. More than 80% of the startups we work with use such top-ups as a key talent retention lever. Few principles for PL grants:

– Consistently link it to the PM process and talent potential
– Have an allocation framework, which is typically ~0.25x of CTC at the grassroots level up to 1.25x of CTC at leadership levels.

We have also seen citizenship grants for tenured employees work well in ringfencing
key talent. Do plan for citizenship grants if you’re a late-stage startup or a listed company.

  1. Creative Vesting Schedules

The most common employee-centric vesting schedule is 25%, split across 4 years, post the 1-year cliff. It operates on the principle that ownership gets unlocked at the same rate as one’s tenure/contribution. The following are some examples of creative vesting schedules:

– Shorter vesting wherever relevant—for instance, a company had 1-year vesting for grants given in lieu of a paycut.
– Waiving off the 1-year cliff for performance grants.
– ‘Daily’ vesting.
– Employee performance-based accelerated vesting.

A logistics startup with a (10,20,30,40)% vesting model split across 4 years for PL grants (with no guaranteed buyback) saw employees perceiving it as ‘paper money’ and high attrition at the 2-year mark. Strongly avoid this practice of backloaded vesting for retention. In most cases, it has the opposite of its intended effect.

  1. Build a structured framework to allocate ESOPs

    A lack of framework leads to structural unfairness and a lot of time spent on ad hoc decisions for every offer. I often hear founders say something along the lines of: “Looking back, I gave almost 1% for a relatively non-critical role” or “The skin in the game for leaders is not enough”.

Spend time on how the ESOP allocation should look across levels. An example of an ESOP grants framework that works really well is the pay mix model:

*Cash 90% (Entry role) | 80% (mid-management) | 70% (leadership)
**ESOP 10% (Entry role) | 20% (mid-management) | 30% (leadership)

*combined fixed and variable **basis current value — All %values as part of CTC

You should further fine-tune this framework on factors such as your startup’s stage,
levels and competencies, total rewards, etc.

  1. Communicate, communicate, and communicate some more

    Fair rewards are a big driver of eNPS in the ecosystem. Employees who feel they are not being rewarded fairly have an eNPS of -12, the biggest theme being “it is a black box”. Recently, a company was able to move its fairness score from 60% to 80% on the strength of good storytelling about its rewards and ESOP proposition alone. A few practices known to help in this regard are:

    – Transparency on ESOP philosophy.
    – Transparency on mechanics like current FMV, valuation, exercise price, etc.
    – Different communication channels: ESOP 101s, grant letters, payslip with
    – ESOP earning potential, ESOP tool, AMAs, etc.
    – Success stories of previous buybacks.
  1. Create a robust buy-back policy

    Regular, planned buybacks help establish the value of ESOPs and drive periodic wealth creation for your people. A good time to start would be Series B onwards, the frequency really depends on multiple factors like PnL Design, Growth, Funding etc. Having said that, annual buybacks are the most impactful. A couple of principles to keep in mind though:

    – Balance between retention and wealth creation (not more than 50% of vested options).
    – Uniform principles across all levels (for fairness and simplicity).

  2. And finally, introduce standout features to your plan!

    Over the last five years, the startup ecosystem in India has introduced innovative features to differentiate their positioning for employees, a few examples being:

    Anytime Liquidation: As long as employees’ shares are vested, they can sell them whenever they want.
    Accelerated Wealth Program (Cash to ESOP conversion): Each full-time employee can convert up to 50% of their annual CTC into ESOPs.

I hope you found the above seven ESOP tenets helpful. Should you wish to talk more about any of these, please reach out to Arun Vigneswaran, who leads the People Excellence charter at xto10x. Arun and his team have successfully implemented this framework at some of the most loved startups in the ecosystem.

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Last modified: May 4, 2023