Understanding ESOPs: Empowering Your Financial Future in Startups
Heads up!
This summary and transcript were automatically generated using AI with the Free YouTube Transcript Summary Tool by LunaNotes.
Generate a summary for free
If you found this summary useful, consider buying us a coffee. It would help us a lot!
Introduction
Joining a startup can be both exciting and daunting. One of the attractive perks many companies offer, particularly startups, is Employee Stock Ownership Plans (ESOPs). In this article, we’ll delve into what ESOPs are, how they function, and discuss both the potential benefits and the risks that come with accepting these as part of your compensation package.
Understanding the intricate balance between salary, incentives, and ESOPs can significantly impact your financial future. Let’s explore this from various angles, ensuring you’re well-informed to make the best decision regarding your next job offer.
What are Employee Stock Options (ESOPs)?
Employee Stock Options (ESOPs) are a type of employee benefit plan that gives workers ownership interest in the company. ESOPs provide employees with an option to buy shares of the company’s stock at a predetermined price, known as the exercise price, after a specified duration. Here’s a deeper look:
H2: The Structure of ESOPs
- Ownership: By receiving ESOPs, employees essentially own a slice of the company.
- Incentive for Performance: This structure encourages employees to contribute towards the company’s growth, as their financial gain is directly tied to the company's performance.
H3: The Basics of ESOPs
- Exercise Price: This is the cost at which employees can purchase shares. For example, if the exercise price is set at ₹1,000 and shares are initially valued at ₹10,000, the employee stands to gain significantly.
- Exercise Period: This marks the timeframe within which employees can buy the shares after their options vest.
How Do ESOPs Work?
Let’s break down the process of how ESOPs operate in startups. This explanation will help you assess their value effectively.
H2: Understanding Vesting and Cliffs
When you are granted ESOPs, they typically come with a vesting schedule and a cliff.
- Vesting Schedule: This is the timeline set by the company that determines when employees earn the right to purchase their shares completely.
- Cliff: A cliff is a minimum period (often one year) before any of the options can be exercised. For instance, after completing a year, an employee might be able to purchase 25% of their ESOPs.
H3: The Risks of Investing in Startup ESOPs
- Value Depletion: If the startup fails, the ESOPs may become worthless.
- Acceptance of Low Salaries: Employees may feel pressured to accept lower salaries in favor of securing more stock options, an arrangement that can lead to financial strain.
- Lapse of Options: If you fail to exercise your options within the specified period, they will expire.
Transitioning from ESOPs to Financial Gain
Transforming your ESOPs into liquid assets requires strategic thinking.
H2: Exploring Liquidation Options
Here are some common methods to liquidate your ESOPs:
- Public Trading: If your company goes public, you have the opportunity to sell your shares on the stock market.
- Acquisition: If your company gets acquired, you may have the ability to cash out your options.
- Company Buy-back: In some cases, your company may offer to buy back your shares at a predetermined price.
H3: Tax Implications of ESOPs
- Tax upon Exercise: Taxes are due at the time of exercising your options. Ensure to factor this into your calculations.
- Capital Gains: Any gains upon selling the shares after exercising are subject to capital gains tax, which can vary based on the holding period.
Decoding ESOPs: The Good and Bad
H2: The Benefits of ESOPs
- Financial Upside: If the company does well, you could significantly increase your initial investment.
- Sense of Ownership: ESOPs can foster a sense of commitment and identification with the company’s success.
- Talent Retention: Companies use ESOPs as a tool to attract and retain talent in a competitive environment.
H3: The Pitfalls of ESOPs
- Market Risks: The startup could fail, leading your stocks to be worth nothing.
- Complex Plans: The terms associated with ESOPs can be convoluted and vary from one company to another, requiring careful review.
Checklist for Evaluating ESOP Offers
When considering a job offer that includes ESOPs, keep these points in mind:
- Written Promises: Ensure that any discussions about ESOPs are documented.
- Accelerated Vesting: Check if there are terms regarding accelerated vesting in case of company acquisitions.
- Salary vs. ESOP Balance: Don’t let the allure of ESOPs overshadow the importance of adequate salary.
- Visibility of the Company: Determine if you’re joining a reputable company—ideally, one that is publicly traded.
- ESOP Policy Document: Familiarize yourself with the company's ESOP policy for clarity on how it operates.
Conclusion
In summary, ESOPs can represent a lucrative opportunity but come with a host of complexities that require careful consideration. Understanding how they work, associated risks, tax implications, and the opportunity for growth can provide a clearer picture for making an informed decision.
The journey in the startup world can be thrilling and financially rewarding, but it's vital to have a solid grasp of concepts like ESOPs. This not only equips you to negotiate effectively but also helps you maximize your career potential. Remember to always seek clarity and ensure that your employment terms align with your financial and career goals.
hello hi T I'm Nish I'm calling from Bo bot hi Nisha so we were really impressed by your profile and we wanted to give
you 10 lakhs per anim and 20 lakhs in stock options oh wow really thank you so much yeah and oh I'm I'm really sorry
Nish I'm getting a really important call can you just hold for a minute ha no problem hello hi Tanya this is shiwani
from Viper Tech hi Shani uh Tanya first of all congratulations you have been selected as Instagram manager in Viper
tech oh wow thank you you're welcome so actually Tanya we want you to discuss your salary okay since uh we are a
starter we can only give you 7 lakhs in the beginning but we'll be giving you 50 lakhs of company
esops 50 lakhs that is a lot of money Tanya are you there uh sorry yes I I accept the offer oh that's great I'll
send you the offer letter and you can join from next week okay thank you bye okay bye congratulations once
again hello sorry for the delay no problem so do you accept the offer uh I'm so sorry I won't be able to accept
the offer I have accepted another offer oh it's okay all the best for your future thank
what okay something was definitely wrong with her expectations about esops now the truth is this is the first de
influencing episode where you don't know how esops work and a lot of people don't know how to select whether esops is
something they should consider when they get a job so in this episode we'll not only explain how they work we'll also de
influence you with any myths you had we'll talk about the good and the bad cuz certainly no one else will tell you
money the answer is but there are some problems with this if you're joining a startup solely because of the shares in
the company beware that this could go to zero and you should be okay with it if you don't buy the shares in the ex
exercise period Then the shares are lapsed can esops make you your first cor the answer is yes but like any scheme
where you can make your first cor there are a lot of ifs and buts and mugger and uger so we'll answer all of that but
before we understand an ESOP let's understand something you already know your salary and your incentive so why
are you really paid your salary think about it you join a company because you are serving a need that the company has
and for for this service the company has hired you and is paying you a fixed salary correct pretty simple now on top
of this how does a company ensure that you go above and beyond your work or you put in your most on things that really
matter they may set certain targets of work and if you achieve those targets not only do you get your salary you'll
get the second form of payment which is your incentive so if you excel in certain jobs or tasks in the month or
your incentive now the company may also give you a yearend bonus but this obviously differs from company to
company now that we've understood salary and incentives they could also be a bonus there's a Third Kind the ESOP guys
can we have silence on set please so there is a Third Kind called esops and a great way to dude hey you
know actually what I'll just use the pizza as an example it will work I think excuse me can we eat this utan please UT
pick it up pick it up pick it up pick it up right here this is mine now thank you bye-bye okay so the way you think about
an ESOP or an employee stock option plan is exactly like shares in a company so if you go and buy one share of Reliance
you are now an owner of Reliance I'll be a small one but an owner represented by one share this pizza is exactly like the
the shares of a company I have 12 slices over here representing the 100% shareholding of one private company and
let's say we have two Founders who begin this company let's assume that there is no investor in this case it's just
easier to calculate let's also assume they're equal shareholders and they each own six slices of pizza now these two
guys have one problem the problem is they're not able to attract enough Talent so they think since they have
this groundbreaking idea they will give shares of this company which is right now worth nothing to these other
employees and these other employees let's say are these two guys these two people now own shares of the company how
much should we give them should we divide the entire p and make it equal of course not because the founders have
taken more risk than the employees maybe they started the company a couple years ago maybe they didn't take salary etc
etc the risk was higher so what they do is they take out one slice over here this one slice and call it the
employee stock option pool this one slice will be divided amongst all the employees they hire in the future now
the beauty is this in the one chance in the faint chance that this company does extremely well and when I say extremely
well I mean financially in that event the employees participate in that upside but remember this is when you get an
ESOP you're not only taking risk because it could go to zero you're also participating in an theoretically
unlimited upside so why do founders explanation yeah okay so why do founders give away their precious shares to
employees there must be some reason right the first reason is to retain good talent and this is for good reason right
I mean if you want to retain Talent they must feel like they own part of the company and they must feel like there is
some upside Beyond just their salary and their incentive they feel if the company does well they will be rewarded so this
is a great way to retain Talent the second reason is probably the most important reason and that's to feel like
you're a owner of the company think about how many of your friends work in dull lifeless jobs Thinking by Weekend a
I'll enjoy myself in the weekend because I have to work from Monday to Friday what if this was F
what if your hobby was actually your job and you truly really enjoyed it well one way to do that is the reason we like
music art dance and to create stuff is because we can call it our own there is a sense of ownership in art which is why
we love art but in many cases in corporate life you feel like a cog in the wheel it doesn't feel like you own
it one way to show ownership is to actually give the employees ownership once they have it and a little part of
their job not entirely but a little part of their job is Art they feel and work better and who wins in the end the
employee wins because he's loving his job and second the company wins because they're getting better output because
everyone feels like they're an owner sure the founders have to give away a lot to get this but isn't it worth it
the last reason is if the company cannot afford a full salary they say Hey you come in half and the rest you can take
as ESOP and that's the way the company can hire good talent hold on this may be a reason but honestly it's a huge red
flag basically someone trying to get you at a cheaper lower rate and compensating with a lot of ESOP may not be best
especially if the company is new so this sounds like a red flag and you should definitely think about it before you
consider it if this happens in your life so how can you turn this piece of paper the ESOP into actual money how can you
liquidate it how can you sell it how do you it the answer is on this board how can an employee liquidate esops so think
is the stock market if the company is listed let's say you're working at Google and you get shares you can just
simply go to the market and sell it it's right there if it's a listed company it becomes a little simpler another way is
an IPO basically if the private company you are working with had shares and it IPOs you can sell it again in the stock
market so that works too another way is an acquisition an acquisition is simply the acquisition of shares or that entire
pizza and in that pizza your esops also exist so you also get an exit there of course there are different versions of
this but well that is one way then we have buy back by the company if the company has cash from profits or
otherwise they can use that money to buy those shares back from you remember esops are like shares so the same way
the founders and the investors exit is the same way you exit but there are some problems with this let's talk about that
the first problem is a substitute for your salary so if anyone says that the shares is a substitute for your salary
please come and join my startup that's not a good thing the problem here is very simple your basic needs should be
covered by a fixed portion that's your salary incentives bonus whatever the ESOP you have to assume could become
zero and it will not affect you for example look at Flipkart and Walmart there was an acquisition there Walmart
said they will buy only 30% of the vested shares of flip cart now this is not in control of the employees the
board decided it and that's the rule so if you're joining a startup solely because of the shares in the company
beware that this could go to zero and you should be okay with it that brings us to point number two the cliff and
vesting period basically it's a actually that's a good way Hey listen listen hey come here come here come here so
works let's suppose this guy say hi hi he has shares worth let's say 30 lakh rupees and this slice of pizza
represents his esops right now the thing is not allowed the cliff basically says if there's a onee cliff it means you are
not eligible to get the esops so I have the worth here but exal bad but after a year his vesting begins so what I'll do
is I can divide this pizza into another three parts if I divide part one and I divide another part two as soon as one
year is over you can pick up one slice this is now vested because he's been here for a year after year two he can
pick up the second slice which is another 33% and after year three he can pick the third slice and that's what
Cliff investing is this is how it you make sure that you earn your shares in the company by working over a period of
now and if you think only employees are going through this guys there are a lot of Founders who raise money from very
because now we'll talk about exercise price and exercise period it's very simple the value of each of these slices
is 10 lakh Rupees 10 lakhs 10 lakhs 10 lakhs but these are shares so you have to buy the shares
right so there'll be an exercise price remember you you don't have stocks you have esops which are stock options you
the option to buy it if you don't want to buy it don't buy it so each stock I'll offer to you at an exercise price
of 1,000 rupees so you can buy all three for 3,000 rupees so that's the exercise price and then there's exercise period
where you're allowed to buy these shares and that's called the exercise period so companies do this exercise period and
exercise price at different ways so everyone has their own rules and if you don't buy the shares in the exercise
period Then the shares are lapsed so these are just some rules you could know but to really know the rule
you'll have to ask your company of what their rules are because it becomes unique for every single company cool now
once you're ready to exercise it you can actually eat that slice so you can go ahead and do that and brings us to
problem number four taxes let's suppose that this 10 lakh Rupees of shares is now vested with you and you exercise it
lakhs and you'll pay that amount and now you own that slice feeling good now let's say the value of this pizza
doubles therefore the value of this share also doubles so it's gone from 10 lakhs to 20 lakhs now at this point the
company buys back the shares from you and you now make 20 lakh rupees but the government says dude you paid tax on 10
lakhs now it's worth 20 so you've earned that extra 10 lakh Rupees so you've got to pay a short-term capital gain or a
long-term capital gain on top of that in private companies a short-term capital gain is 2 years and above that is
longterm and the tax labs are different for a shortterm you pay equivalent to your tax lab for a longterm you pay 20%
flat for a public company the rules are a little different and it's right here in many cases the exercise price and the
buyback happens at the same time and if that happens then this calculation is not valid you just simply find the gain
pay tax on it and it's over so it's a lot more simpler and finally I have a checklist okay thanks good job
bye-bye the checklist is pretty simple if you're joining a startup or a really large company these are some things you
should think about before you actually accept the ESOP Point number one written promises if the company says they'll
give you ESOP especially when you've not joined the company make sure you have physical proof of the promise either in
your office a letter or anything else second accelerated vesting this means if the company's bought out by another
company you'll start working for the new company and you'll get a new cliff and a new vesting period which means those
numbers increase so you should know what you're signing up for Point number three find the right balance if the company
you're joining is offering you a really low salary for the esops make sure you trust that company will grow enough also
your inhand shouldn't be low because how will you manage your own expenses number four listed companies if you're joining
a listed and valuable company like a Google or Amazon getting esops is a no-brainer because you can sell it in
the open market when you want and you can pay taxes on the profits you book but having said that getting esops in a
very large company is not as easy as getting esops in a smaller company because a lot of large companies give it
to only their Prime big management and they get access to it also you should read the ESOP policy document to
understand how the ESOP works I hope this episode was useful I know a lot of people don't see esops in their lives
but now you know that this tool exists let us know what other topics to cover in the comments below say d influencing