PJ tweeted this excellent summary & this topic needs more details.
This post covers:
1. How founders need to look at ESOPs
2. How we handle ESOPs at Markk
3. What founders should do if they make a promise & do not have the paper work in place (when an exit event happens)
- Founders and ESOPs
One of the biggest motivations for me as a founder is when people who trust you & your vision early days make money. A lot of money. This includes all shareholders like investors, but employees come first.
As a founder you need to realize that wealth creation happens best when you take everybody along. It is also in your selfish interest to let people have ownership and create a win-win.
Recommendation: Have a 10% pool for ESOPs (to start with)
2. How we handle this at Markk
A benchmark against PJ’s table above
| Topic | Markk Policy | Score |
|---|---|---|
| Who is eligible for ESOPs | Everybody | Outstanding ✅ |
| Vesting period | 4 years | Outstanding ✅ |
| Vesting schedule | 10+20+30+40 | Average 🆗 |
| Allotment is | Time Linked | Outstanding ✅ |
| Vesting starts from | Joining date | Outstanding ✅ |
| Top-up of ESOPs | Not defined | Average 🆗 |
| Vesting on leaving | Vested Options | Outstanding ✅ |
| Vesting on Exit | Accelerated | Outstanding ✅ |
| Sale of vested stocks | Permission required | Average 🆗 |
| Sale of ESOPs | Facilitated | Outstanding ✅ |
| Buyback | Not defined | – |
| Exercise Price | Reasonable Price | Good 👍 |
| Holding period | 7yrs | Good 👍 |
There are 3 additional sections that need to be considered
| Death / Disability | Automatically vested to heir / employee |
| Applicable to freelancers | Yes! ✅ |
| Cash out Vs Stocks | Yes! ✅ |
Vesting Schedule:
A equal vesting schedule should not be done in early stages of your startup. Startups are tough and take years before things add up, and majority of people will leave before things start looking good.
If you keep equal vesting each year you do not reward patience and also end up probably losing lot of equity for people who are not willing to play the long game.
Top-up of ESOPs:
Though we have already topped ESOPs for most employees (either based on performance or in lieu of salary), this is something we will define.
Sale of vested stocks:
A no permission situation works well once the startup is big and secondary sale is an option. Else, permission should be needed to ensure shares are not sold to competition or people you do not want to work with.
Buyback:
Again works after a certain stage of maturity of the company. We do not have this defined, but I will be more than happy to facilitate this when we are there.
Holding period:
Only reason we do not have an infinite holding period is this makes calculation of outstanding options difficult and also sometimes tracking of people (who have left years ago) and getting them to exercise can get painful!
Available for Freelancers / Contractors:
Sometimes you would like to engage with high quality talent (who are not open to full time employment), by ensuring your stock plan can reward such people is very important. Why?
a) You will not be afford this talent otherwise
b) Such talent will usually also want to own stocks.
Cash out vs stocks:
Stock rewards are delayed monetary gratification. Yes it also means you are an ‘owner’ but this ownership value will invariably be very small.
What matters finally is how much money can you make from that paper you hold. Based on this we have an option to directly pay cash to people (for the stocks they hold) or actually get them to own stocks. This works well especially for people who have left your organization and saves you on lot of paperwork otherwise needed for ‘shareholders’
Founder makes a promise but does not do the paperwork
There are many situations where the paperwork genuinely gets delayed (or forgotten by the founder).
– You are more focused on executing and surviving
– Paying lawyers and getting this documented is not on your mind
– You promise ‘x %’ to employees (with promise to do paperwork later)
– Then one day some outside investment happens or there is an exit event. There is no paperwork in place!
– The ‘x%’ promise is at best on email or usually as a conversation between the founder and the employee.
What should a founder do in such a situation?
Simple answer: Always honor your word. Apart from karma which will one day come to bite you, you also need to remember that as a founder the biggest credibility you have is your integrity.
Personal experience of how we handled this in TastyKhana:
This was my first startup and I had no clue how ESOPs work. As mentioned above I promised early employees stocks and never bothered to do the paperwork. (In hindsight, a very bad example)
Long story short, at our exit event we had no ESOPs in place and only promises that we had made.
Sheldon & I paid money (from our share sale) personally & also ensured we adjusted for the tax loss they had (from a share sale vs direct income)
I personally know many founders (with much celebrated exits) who have played foul on promises and pushed this to board, investors etc. But it is simply greed getting better of them.